By Michael Every of Rabobank
Jurassic Poo-ark
This week starts as last week ended, with US election month (because that’s what it now is) confirming the Democrats keep the Senate but narrowly lose the House, while markets grapple with FTX taking us down the meme path of Lehman > Bankman > jail, man.
After all, the firm was allegedly using client deposits as a piggy bank to be traded by its Alameda Research arm. And not very well. As someone tweeted “It’s a real mystery how a company run by such a seasoned CEO could go bust” alongside the screenshot headline ‘CEO of Alameda Research is a 28-Year-Old Harry Potter Fan’, and a picture of someone who looks like they live at Hogwarts. Below are clips of her being interviewed in which she states she uses “elementary school math” to do her risk analysis, and cannot remember losing money trading. The risk of this kind of mess was always as obvious as the vast pile of dinosaur droppings in Jurassic Park to those of us who were called dinosaurs by the ones choosing to jump into it.
Honest appraisal and debate about crypto can now be held freely on Twitter – for as long as it is around. There, we’ve just seen a series of corporate imposters offer free insulin, to stop selling weapons, or pledge to be the world’s largest plastic polluter for the fifth year in a row. That’s what happens when you can buy accreditation for $8 a month while allowing free speech. Corporate advertisers are now embracing rival TikTok: the Chinese app that operates on wildly different principles there, harvests user data, and which Western hawks say is a national security threat needing to be banned. Go do that Jurassic doo-doo that you do so well.
The rest of the market is still showing a dinosaur-brained response to the weaker US CPI number last week. ‘Transitory’ trades are back with a bang: bond yields lower, except in Brazil, as post-election looser fiscal policy emerges(?), equities higher, while the dollar is trading like it’s 2009 when that fate is only befalling its crypto rivals.
To those who think looking at a Bloomberg screen is “understanding inflation”, note that there were some odd things in the October CPI report: energy prices going down when they actually went up; a drop in medical expenses that won’t be repeated; and a slump in used cars that hardly speaks to core services inflation continuing to head higher.
To those who think looking at a Bloomberg screen or the Fed-whispering of the Wall Street Journal counts as “understanding central banks”, note that loosening financial conditions like this is exactly the outcome that will risk Powell going 75bp in December, and having to continue to do even more. You push yields lower, he pushes rates higher. It’s not hard to grasp unless you were bullish FTX. To make that even clearer, Taylor, as in ‘The Taylor Rule’, just told a conference that ‘Fed May Need to Raise Rates to 6%’. Moreover, ‘Nickileaks’, as some are dubbing the WSJ Fed channel, who sometimes gets called by dovish Brainard, is now quoting the Fed’s Waller, who says of the October inflation number:
"The market seemed to get waaaa-aaaay out in front.... I just cannot stress this is one data point…. We've still got a ways to go." On the loosening of financial conditions that followed Thursday's market reaction: "This is exactly the situation we had gotten into in July… a loosening of financial conditions that we were trying not to do." Waller sees 7.7% y-o-y CPI inflation as "enormous,” and if inflation expectations were to become unanchored, you wouldn't see it happening with a lot of advanced notice in the data: "You don't pop a balloon slowly. Once it goes, it goes." If you use a Taylor-type policy rule, short-term interest rates aren't that high: "We're not that tight. Real rates are barely positive a year out." The FOMC statement in November was designed to signal a potential steep down to 50bp and "We knew the markets were going to jump for joy," so Powell's press conference was used to "drive the point home" that it's the ultimate level for rates that matters. And that will only go up the more markets try to price for a pivot.
Yet there are more signals of pivots from China, which are inflationary. We just saw 20 measures that institutionalise Covid Zero further but take some of the edges off, and a further state bailout of the property sector. Of course, neither plan will work. Covid restrictions are just that; a property bailout needs consumers to absorb out of line prices and out of line supply, which is out of line with Common Prosperity. Yet the attempts suggest more inflation on the commodity side.
Meanwhile, promises to address income and wealth inequality, whispers of new tax units to target high income individuals, The Economist arguing ’Xi Jinping amends the Chinese Dream’, the Financial Times reporting ‘China’s elite seek safety abroad’, and Alibaba not reporting Singles Day sales (but some suggesting spending was -42% y-o-y), all lead to Bloomberg saying ‘Global Banks Are Quietly Cutting China Jobs as Big Bang Fizzles’. They add:
“…a slump in deals and growing political tension force global banks to recalibrate their plans to conquer the $56 trillion financial market. In public, executives say they’re in for the long-haul, but behind the scenes banks… have jettisoned China-focused investment bankers. Some global banks expect to cut more next year and are prepared for major staff exits as bonuses vanish. Doubts are growing over whether China will ever become the deal and fee machine once envisaged. “It’s clear China can switch direction and crack down quickly as has been shown in many industries in recent years,” said Christopher Marquis, Sinyi professor of Chinese management at Cambridge Judge Business School and author of ‘Mao and Markets.’ “Particularly banking is tied to general national security, which has really been shown in recent years to be the dominant logic of Xi, above and beyond economic growth.”
Nothing that anyone could have noticed in advance, of course. (As an aside, I would suggest fleeing rich Chinese may avoid the UK, where the rich are now to be soaked with de facto tax hikes along with the middle class, rather than saturated with tax cuts, as austerity is embraced all over again into the face of a deep recession – and openly sold as necessary ‘because markets demand it’. Yes, this will end as well as you think it will.)
Against this kind of backdrop, today will see Biden and Xi meet at the G20 in Bali in an attempt to determine where their respective ‘red lines’ are drawn, according to the former - in short, an attempt at saying “C’mon, Man!” to settle things.
Those wanting to see détente, for example the authors of ‘How to Build a Better Order: Limiting Great Power Rivalry in an Anarchic World’, suggest the "existing, Western-oriented approach [to address] the many forces governing international power relations" is "no longer adequate" and another order that "accommodates non-Western powers and tolerate greater diversity" should be built. (Because the US is all about diversity, right?) The authors propose achieving a more stable multipolar world order is "not as hard as it might sound" if all adhere to "a simple, 4-part framework to guide relations among major powers."
- Agreeing on prohibited actions, or "norms that are already widely accepted by the US, China, and other major powers", to set "boundaries to acceptable actions";
- Pushing for "actions in which states stand to benefit by altering their own behaviour in exchange for similar concessions by others", like "bilateral trade accords and arms control agreements";
- States are "free to take independent actions to advance specific national goals, consistent with the principle of sovereignty but subject to any previously agreed-on prohibitions.” On matters of national security, the framework "dictates that such actions must be well calibrated [and] proportional to the security threat at hand and not designed to damage or punish a rival."; and
- States should collaborate on "issues in which effective action requires the involvement of multiple states", like climate change or pandemics.
Et voilà - peace for our time! John Kerry and Henry Kissinger are already doing cartwheels in anticipation.
So will markets if they get the slightest sniff of this happening. Which will of course be inflationary. And loosen financial conditions. And set the Fed off on more aggressive hikes that destabilise the emerging new détente. Unless part of that détente is the Fed stepping back from either fighting inflation, or its global hegemony – in which case it won’t be happening voluntarily in Bali.
Ironically, one of the above authors is Dani Rodrik, who built on the ‘impossible trilemma’ of an open capital account, exchange rate stability, and independent monetary policy, which explains why our global Bretton Woods 2 blew up, with his ‘Globalization Paradox’ that it is impossible to attain economic hyperglobalisation, national sovereignty, and democracy simultaneously because only two of these things can be achieved at one time – which explains why hyperglobalisation is blowing up. He is now pushing for bilateral trade deals and climate agreements that have trade components attached (as the EU have noticed) as if this resolves problems he points out.
Indeed, the framework above, while laudable, makes as much real world sense as the often-heard foreign policy critique that “If only you agreed with me, there would be no disagreement!” It’s a well-intentioned milquetoast reiteration of centuries of international relations theories going back to Westphalia – when we are in an age of potential West failure. It arguably doesn’t capture the political reality of: war in Ukraine, as Russia retreats from Kherson, but Pepe Escobaw-Haw claims the next step is a sweeping advance to Odesa; street protests in Moscow calling for the use of nuclear weapons(!); US Treasury Secretary Yellen saying US sanctions will stay on Russia whatever happens; the impossibility of the US doing a sudden U-turn on its national security strategy or controls on Chinese access to high-end semiconductors; or the fundamental precepts of Marxist-Leninist theory that global investment banks won’t read but are now belatedly recognising.
There is also the fat tail-risk of a Biden-Xi meeting that goes as badly as the recent US-China one in Alaska. After all, Taiwan is a topic of conversation.
To conclude, the simple image to take away today is that of a Jurassic pile called FTX and crypto; that market cheer at last week’s CPI will ironically lead to them falling face first into it a similar pile instead; and that the geopolitical backdrop is an even larger pile, and yet where détente only raises the risks of more inflation, and so more face-first falls.
