Drawing on a spectrum of global fixed income opportunities to meet a range of client goals
I’m the sort of annoying office colleague who - among my many fidgets, tics and other mostly involuntary habits - sings at my desk. Not a little bit. But a lot. I mean like all the time. Every day. Not loudly while standing on the table (that sort of behaviour is reserved for karaoke booths) but relatively quietly and under my breath. Whether that makes it any less annoying is for my colleagues to answer. The singing is voluntary, but on most occasions the choice of song is less so. It’s a kind of earworm thing. I can’t normally explain why I am singing Cliff Richard’s classic “Summer Holiday” in December or Elton John’s rather underrated “Cold as Christmas” in June.
One of the most common refrains in recent months has been one of REM’s golden oldies. Unfortunately I don’t know any of the words apart from the eponymous riff – “It’s the end of the world as we know it…it’s the end of the world as we know it” (repeat ad nauseam). But I don’t let that minor detail get in my way.
Unlike most of my other song ‘choices’ I know exactly why I am singing this bad boy. My day-to-day job involves observing markets, scrutinising data releases and interpreting research. I have to form a view about what this input is telling me about the global economy, politics and (of course) financial markets.
In recent months, I have come to the inexorable conclusion we are experiencing something akin to a Mexican standoff in markets. It may, at first glance, appear as if low volatility is a sign of a world at ease – a stately liner gliding effortlessly across the calm seas of the global economy towards a better and brighter tomorrow.
But if you scratch beneath the surface you uncover a pool of evidence that things aren’t quite so hunky dory. I think we saw a little glimpse of the future in March. And it wasn’t pretty (unless you are long duration and long the Japanese yen.)
First, let’s recap on some of the events of the recent past. The year 2018 was the year of Quantitative Tightening (QT). and what is QT, I hear you ask? Well it’s the opposite of Quantitative Easing (QE), of course. Remind us – what was QE? An easy thing to forget – after all, this is fairly dry and tedious stuff. QE is the process whereby a central bank purchases assets from banks using electronic “money” it has created out of thin air. It is supposed to stimulate economies and create inflation.
And yet…it does nothing of the sort – unless, that is, the inflation you wish to create is of the prices of financial assets and other vehicles that will help the rich to get richer. QE doesn’t work. It just creates distortions, bubbles and inequality. But that doesn’t stop central bankers engaging in it. After all, they have fancy degrees in pseudo-science and their spreadsheets tell them it’s a good idea. If the world disagrees? Well, then the world is wrong. End. Of. Story.
But after Jay started to take away all that lovely financial Methadone, all those nasty financial asset prices, distortions and bubbles began to unwind and pop.
Thankfully, 2018 was the year where the US Federal Reserve (Fed), under the leadership of shiny new chairman Jerome “Jay” Powell, was going to begin the long-overdue process of reversing this absolute nonsense. But after Jay started to take away all that lovely financial Methadone, all those nasty financial asset prices, distortions and bubbles began to unwind and pop. What happened next was as inevitable as it was predictable. Jay Powell did what numerous Fed Chairs have done before him, and capitulated. Not a little bit, not at the margin. But a full-on, 180° fold. Like a cheap suit.
Numerous excuses were attempted. The Fed pretends it targets full employment and stable prices, targeting 2% Personal Consumption Expenditures. But what it actually does is prop up financial markets. Heaven forfend that anyone should lose money with unwise and levered financial market investments (aka speculation). That just wouldn’t do. So while in 2018 we saw a fall in the prices of pretty much all financial assets, we started 2019 with the exact opposite. The mad rush to get back in the pool saw a rally in the prices of bonds, equities, commodities, even Bitcoin. Most asset classes experienced one- or two-month returns that one would normally associate with a full year or more. Hence, bubble-pop averted. Nice job, Jay.
But March afforded us a glimpse as to some of the problems which the Fed chair can’t solve by encouraging idiotic speculation. It also gave us an insight into the psychology of financial market participants – and, thus, the folly of the model favoured by economists everywhere which assumes no such thing as psychology.
Powell’s journey from responsible central banker who vowed to “remove the punch bowl” to just another purveyor of moral hazard has been a rapid one. His descent only began in December 2018 before continuing into the first quarter of 2019. Then, in March, Powell added even more dovishness. The problem is that the market started to suspect that the central banker doth protest too much. So instead of the intended effect - happy markets rushing to price in a riskless and certain future - investors started to panic a little.
“What does the Fed know?”, they asked. Nobody seemed to know the answer, although I rather suspect that it was “absolutely nothing”. Rather than wait for answers, markets did what markets are wont to do. They behaved as if things were bad. Act first; ask questions later…or never. Hence, government bonds rallied, equities ran around with their hair on fire and currencies perceived to be “safe” outperformed those deemed to be “unsafe”. The yen did well. EM currencies? Not so much. This was good for some funds - but it came as a surprise to many.
So what’s really going on? In the preceding paragraphs I have - purely for cathartic and comedic effect - embellished a little and left out a few key details. For while the Fed has been on this wondrous journey the US economy has slowed a little. However, outside of the US things have started to look pretty gnarly. Because it wasn’t only the Fed taking away the punchbowl in 2018. China, the world’s second largest economy, was doing the same. Unfortunately for the many mercantilist economies around the globe (The Eurozone – Germany in particular, and pretty much any economy in south east Asia are the main ones) it turns out that when they took away the punchbowl in China, things just stopped. The environment in which the Fed added its latest soothing nonsense to the financial market bubble-fest was one of dramatically weaker data in many of the world’s other largest economies.
And it is this last piece which brings us back to my annoying REM earworm. It may well be that the first quarter of 2019 gave us a glimpse into the future. In 2008 the world’s economies and financial markets almost collapsed under the weight of the excessive and ill-considered debt – debt which had been force-fed to financial markets by academic central bankers with a rather simplistic and abstract model of the world. So in the years following 2008 we all turned once more to these “sages” for help. Don’t ask me why. What they delivered was more of the same - more debt to cure a problem created by debt. Is it just me, or does that sound like a Ponzi scheme?.
The problems here are many and various. But the one which is now starting to rear its head is what economist Richard Koo describes as ‘The QE Trap’. Essentially, he says, when the economy starts to look a bit more normal central banks are mandated to point policy in the other direction. But at this point all those bubbles start to pop. This ‘forces’ central banks to step back lest capitalism is permitted to function as it should (i.e. ill-conceived investments by ill-informed investors should lose money).
And so that’s where we are. Markets are in a stand-off with central banks. The reason that we are positioned defensively - in spite of all this idiotic exuberance - is that at some point the economy will roll over anyway. And at that point, all the soothing central bank rhetoric in the world isn’t going to prevent markets belatedly recognising that central banks have solved nothing and have merely spent 10 years kicking the can down the road. Is it the end of the world as we know it? Watch this space.