When Fed Chairman Jay Powell cleared his throat to speak at the Council for Foreign Relations this week, the air was one of rapt attention. [To listen instead to my podcast on this, please go to CantillonCH at SoundCloud, or search Apple Podcasts and Spotify for ‘Cantillon Effects’]
The heed we pay to the pronouncements of men such as Mr. Powell is, in many ways, a remarkable feature of the Modern Age. Progressively through our lifetimes – and especially since the late unpleasantness of the GFC – high-ranking technocrats such as he have become elevated in our regard into a sort of cross between the Delphic Oracle and a Roman augur.
Though the former’s, the Pythia’s, words were almost impenetrably equivocal, upon their interpretation turned the fate of nations and the fortune of kings. Her text had thus to be carefully parsed for meaning, even if it was often carefully contrived to let the person consulting her believe she had blessed a course of action upon which he had already, long since decided, while supporting the exact opposite construction if his aspirations all subsequently turned to dust.
If the current Fed Chairman is a good deal less circumlocutory and decidedly less given to MIT macro-mumble than his predecessors, the humble hedge-fund suppliant at his shrine must nevertheless still work hard to penetrate to the inner truth before telling his broker to sell a thousand Junes at market – not least because our Oracle doesn’t often seem to know, from one speech to the next, what exactly is the message that he intends to convey.
Much like an Ur FOMC, the college of Roman augurs, too, had a prominent role in the affairs of the Republic. In the run-up to every big event, its members would be out, scanning the skies for the passage of a flock of birds or studying a solitary eagle as it soared, so as to be able to commend – or occasionally to condemn – a coronation, a carnival, or a military campaign.
Being a plural body, of course, and also being charged with the interpretation of a whole multitude of different natural phenomena, ranging from peals of thunder to the scratching in the dirt of the sacred Martian chickens, opinions as to the advisability or otherwise of some course of action could vary greatly across the priesthood.
Just as in the time of Cicero, our official diviners can also violently disagree, as we see when a Kashkari shrieks at surveys showing signs of ‘unanchored inflation expectations’ among the good folk of Minneapolis – and so howls for an immediate 50 basis point cut – while a Kaplan calmly counters that HIS chicken’s entrails reveal a ‘trimmed-mean PCE’ that is not only consistent with the talismanic 2% ‘target’ rate of price rise, but poised to move higher beyond it.
The reason so much weight is now given to these prognostications is that, in the business of post-Crisis professional investment, one’s principal job is increasingly not to analyse the minutiae of the free cash flow being thrown off by and the accounts receivable being accumulated during the operations of some established maker of widgets since – the chances are – its major shareholders are either Eyeless in Gaza – blind slaves bound to some index or other in which the stock is included – or the firm is sponsored only by being forcibly bundled into the anonymizing sausage-machine of an ETF alongside some loosely-compatible gallimaufry of other, readily-marketable, ‘theme’ counters.
These, of course, being all lashed tightly together at the mast of the Ship of Fools, will tend to rise and fall with the level of hype or harrumph being generated by the likes of Mr. Powell, regardless of their individual merits, thus making everyone into lowly chasers of beta – smart or otherwise, leveraged or not.
Narcissus’ Pool
In an evolution from the practices of old which we should not necessarily regard as constituting an unalloyed advance upon them, our latter-day Haruspices do not rest at merely reading meaning into the random flight of, say, a heron, but they have arrogated to themselves wide, previously unthinkable powers to determine the location, number, and breeding rituals of such specimens; to flush them, on demand, from the habitat so provided; and even to direct the timing and bearing of their flight.
Moreover, in another highly suspect departure from their predecessors’ methods, the Seers of the Marriner S Eccles building have come to add to the list of tangible omens – jobless rosters, inflation rates, production totals, and their ilk – a whole spirit world of unobservable ones – ethereal concepts such as ‘natural’ rates of interest and employment or the ectoplasm of ‘expectations’.
Finally – and perhaps most perniciously of all – like some Victorian parlour trickster who convinces herself that she really IS in touch with Dear Cousin Marmaduke on the Other Side – our necromancers have become besotted with gauging the reaction of the audience to their signs and portents making it something in which they contrive to find in it a new and exciting source of insight.
Neglected in all the numerology of term premia and forward rates is the fact that the Herd is constantly jockeying to get profitably ahead of a Fed whose idiot savants are simultaneously looking at the market phenomena so generated as if the signals which they thereby derive from this circular interplay are as scientifically independent and exogenous as an observatory’s careful, photon-by-photon measurement of the spectral lines emanating from some far-distant star cluster.
To take an all-too pertinent example, the Fed reacts strongly to developments in CPI – in its rhetoric, if not always in its realised rate-settings.
Spot oil prices tend to exert a good deal of influence on short-horizon CPI while a lower CPI is seen as positive for bonds, particularly those at the longer maturities. A fall in the oil price thus not only leads to a rally in 10-year T-Notes, but often to their outperforming bonds of lesser tenor.
Hence, the gap between five and ten years is squashed. The yield curve therefore flattens as we say, a development which sets the tocsin ringing loudly, all on its own. Inevitably, the far less liquid, inflation-linked TIPS which cue off this bracketing pair of plain-vanilla bellwethers also begin to suffer a compression of the difference between them.
Hey, presto! – the current FOMC fetish, the ‘5-year, 5-year forward breakeven rate’ – falls and the Kashkaris of this world give vent to fears of a dragging ‘anchor’. Knowing this, the bond market trades more bullishly still and so fears of an economic deceleration mount – often acting to further depress oil prices!
Before you know it, yields are in a death spiral of witless self-reinforcement and the Fed is soon – as Mr. Powell helpfully disclosed, this week – ‘grappling’ with the question of when to cut rates and by how much!
Swing Traders
Amid the risk asset rout which brought 2018 to a close and before Jay Powell first blinked – or had sand thrown in his eyes by the President – the rate implied for borrowing 3-month money three months into the future (the so-called 3×6 FRA) was 85 basis points over that moment’s Federal funds rate, a relation which was implying that at least three further 25bp hikes were being anticipated. At the last reckoning that premium had swung violently to a 37bp discount and so was pricing getting on for two cuts.
That move – from three up to two down – was the fastest such shift in outlook seen in any comparable interval since the dark days of 2009’s latter half when the Fed was busily buying $1 trillion’s worth of securities and boosting reserve balances almost 60%, or $400 billion. Along the way, roughly $850 billion dollars of 1-year equivalent risk has been entirely reformed by hedge funds, CTAs, and other hot money types as they have stampeded from leaning over the short side of the boat in record numbers to peering eagerly over the long, also as part of an unprecedentedly large throng.
Of course, all this hyperactivity has not been entirely the Fed’s doing. That motel lounge magician who presides over the European Central Bank, Marvellous Mario Draghi, has recently tried to end his residency at the Casino with a big enough bang to reduce any – shall we say, more Teutonic? – replacement’s hopes of quickly ending the Eurozone insanity to a rubble by launching a forward-guided missile of his own. Rate cuts were the least of the hints heavily dropped for he also dangled the prospect of a resurrection of the programme which has seen almost €2 trillion in securities purchases made over the past four years, one which notably hoovered up twice as many member-state government bonds as were newly-issued in that time.
Nor is he the only Sorcerer’s Apprentice conjuring buckets and brooms into life to the sounds of a Dukas backing track. In its so-far fruitless attempt to hit its shamanic inflation goals, the BOJ ploughs wearily on, adding $20-odd billion a month to the pile (much of it leaking out into the notorious Cov-lite bonds being bundled into US CDOs and issued via the Cayman Isles). Elsewhere, the Aussies have cut, the Indonesians have eased, the Indians, too, and even the Icelanders! China is simultaneously in full, hands-to-the-pump, keep-the-plates-spinning, five-alarm-fire mode, yet again.
The irony of all this is that the markets have been led to price in so much easing ahead of its actual delivery (and, in some cases, absent much in the way of any incontrovertible need for it) they would seem ripe for disappointment – if only of the ‘buy the rumour, sell the fact’ kind.
Tainted Love
Meanwhile, nagging doubts persist that the blind alley down which the soothsayers are speeding us ever faster has a very solid brick wall lurking around one of its upcoming bends.
For instance, the BOJ’s Kuroda has many vocal critics both within and without its walls who argue that he is now undermining the very commercial banks his policies are supposed to be rejuvenating. Hamlet’s mother could very much have had Luis de Guindos and others on the ECB Council in mind, too. For, ladies or not, they certainly do protest too much, methinks, in their unconvincing assertions that European banks are not also being damaged by the mix. China’s various big wigs and regulators are also all too clearly aware that they are trying fix the leaks in a fast-perishing hosepipe by banging nails into each and every new hole as it appears.
For our part, we have waxed incandescent in the past about the abomination of a negative rate structure and we have also suggested that the predictable loss of both nominal and real worth which it inflicts on one’s less risky savings is little more than a wealth tax which those who are still inclined to prudence and thrift must set aside increasing amounts to overcome, meaning that a version of self-defeating Ricardian equivalence is here at play.
But rather than repeat our past strictures, let us leave it instead to the recent missive of the aforementioned Dallas Fed, rate-cut sceptic, Robert Kaplan, to make the case that it is not just the drain on savers’ capital or the anti-Darwinian preservation of Zombie companies that makes overly low rates self-defeating, but the meretricious success of those bull market darlings, the Unicorns, too.
We quote:-
“Our view at the Dallas Fed is that the structural forces of technology, technology-enabled disruption and, to some lesser extent, globalization are muting the relationship between labour market tightening and wage gains… In addition, new business models… are disrupting old business models and allowing consumers to have more power in choosing the lowest price at a high level of convenience. Think Amazon, Uber, Lyft, Airbnb and so on.”
Now for the key paragraph:-
“These models are often further enabled by the fact that the cost of capital is historically low, and financial markets are willing to assign these businesses substantial valuations and advance substantial amounts of capital, even though these companies frequently generate little or no profitability in their early years…” or their middle or even their later years, if we take the inglorious example of a Tesla into account!
But back to Mr. Kaplan:
“Against this background, numerous Dallas Fed business contacts report having materially less pricing power today than they have had historically. Based on these discussions, it is our view that as cyclical forces build, which lead to increased costs, these cost increases are just as likely to lead to business margin erosion as they are [to] higher prices.”
Loosely translated we read as follows:-
“Because we central bankers have made a nonsense of interest rates by swamping the world in credit, our capital markets have become a vast Ponzi scheme in which all the insiders extract vast gains from sexy-sounding companies which never actually make a meaningful, economic return on said capital.”
“What such entities sell” – to quote a Texas real estate developer of our former acquaintance – “is all sizzle and no steak and, in doing so, they deny real businesses, whose progress is far less easy for the Wall St. Dream Factory to exploit, all hope of earning a return on their own, much more hard-won capital.”
“Some of my fellow Witch-doctors consider the remedy to the resulting scrabble for revenues – and the ‘below-target inflation’ which that brings – to be to get out our spell books once more and to make an even bigger nonsense of rates by drowning the world – abracadabra! – in even more credit.”
As a result of this latest thaumaturgy, Gold, that perennial bird of ill-omen – as our augurs might put it – has jumped $170-odd bucks to a six-year high, in only a few short days. With financial market stress indicators such as volatilities and credit spreads subdued, this can only be the metal acting – not this time as systemic insurance, but as a refuge from excess liquidity (a polite way of saying, ‘acting as an inflation hedge’).
Flight from Reality
In addition, Bitcoin, for heaven’s sakes, has shot up 165% to almost $14,000 a pop. Another sign of mass insanity, Austria has sold 100-year debt at barely more than 1% per annum to a posse of yield-hungry pension and insurance companies – who are thus willing to risk a capital loss of ~5% for every one-tenth of one percent increase in yields!
At this, we couldn’t resist tweeting:-
“So that infamous #Austrian 100-year #bond has rallied 34 big figures in the last 10 weeks – a 262% annualized return. The bad news? Every 10bp back up in yield costs you 28 1/2 months of coupon income. This is helping whom and how, Mario?”
Finally, Greek – GREEK! – 10-year paper – a troubled category of obligation well on its way to becoming worthless not THAT long since – has traded all the way down to an historically low yield of a miserly 2.35%.
What Mises described as the final inflationary paroxysm of Flucht in Sachwerte – a flight to real values – has, in our Bizarro world, evidently become a Flucht in Unechtwerte – a flight to unreal ones.
But then, this is a market where, with the straightest of straight faces, some analyst or other recently bemoaned the fact that a Euro suddenly rebounding from a 2-year low to a 3-month high against the Greenback in the days after the last ECB meeting meant that Jay Powell’s lamentable defection to the pre-emptive easing camp had outbid Draghi’s earlier démarche and that therefore the latter had ‘lost credibility’ – lost it, one presumes, in what can only be described as his drive to cost the euro whatever remains of its own, tattered credibility!
It seems we are living, not so much in an age of ‘irrational exuberance’ – to quote a former Grand Mage of the Inner Circle – as one of highly exuberant irrationality.