Random Musings on Markets 2019: Highway to Musings

Hello again! This week, in our not-at-all-weekly, not-at-all-regular, not-at-all-planned roundup of quirky financial news, we bring you a bizarre theory on negative interest rates, a weird observation about currency war fears, a European politician’s odd beach tour—and more!

Negative Rates Aren’t Puzzling. But This Isn’t Why.

This week, Bloomberg ran an article arguing negative interest rates aren’t so strange—presuming you thought they were to begin with. The piece leans heavily on the “savings glut” theory, claiming the supply of savings (deposits at banks, etc.) far outstrips banks’ demand for short term funding, making it totally commonplace supply-and-demand logic that rates would be negative. Not that different from commodity markets like pork bellies or wheat. Hey, depositors demand a place to put money and if banks don’t need the money, they won’t pay. Boom. Pure and simple. Basic Econ 101. Except.

Money markets aren’t like other markets, which the article conveniently dodged. This is a … large omission? Many central banks set short-term rates below zero. They dictate that banks force depositors to pay them for the convenience of keeping their money safe. That exerts influence across the short end of the yield curve and influences inflation expectations—and long rates—too. Hence the whole analogy^[i] in the article to property or wheat or barley or hops or whatever is wrong. Those are free markets. Banking isn’t. Long ago, folks decided as a society banks were different than most industries and needed a failsafe to help backstop them via monetary policy and acting as a lender of last resort.

This isn’t to say we think negative rates are so hugely strange. They aren’t. They are questionable monetary policy. But a buyer of a negative-yield bond is simply betting rates fall further. Many of these bonds—especially the longer-dated German or Swiss debt—are especially exposed to pressures driving rates lower, so if that happens, buyers would be able sell these bonds that many presume are a guaranteed loss at a tidy profit. Ultimately, no, negative rates aren’t so incredibly puzzling that we need 1,000 word articles to explain why they exist. But if you think this is a purely free market phenomenon, that is a puzzling point we think would require at least 1,200 words to explain.

The Grand Irony About This Week’s “Currency War”

As the world stewed over the currency war that apparently erupted between the US and China on Monday, we couldn’t help but wonder why markets—particularly US markets—reacted with such vitriol. Yes, currency wars have a bad rap and conjure fears of markets going haywire, with headlines warning of a “race to the bottom” while ignoring that currencies trade in pairs, making the “bottom” mostly myth.

But at the same time, from a pure economic standpoint, we just didn’t get it. Chinese officials’ apparent willingness to allow the yuan to drop relative to the dollar followed President Trump’s announcement that a 10% tariff would apply to all remaining untaxed Chinese imports from September 1 onward. Think about this from an American consumer’s perspective. Presuming retailers want to protect their profit margins, they will hike prices to reflect the tariff. But the whole point of a currency devaluation would be to allow Chinese firms to cut prices here. So Monday’s currency swing, should it flow through to prices here, would help offset the tariff’s impact. That seems like a favor to US consumers and retailers? And potentially for the administration, which might face less backlash if consumer prices don’t rise as much as they otherwise might?

This is just a pet theory, and there are too many moving parts in the economy to ever isolate the impact. But it is one other big reason the S&P 500’s -3% drop on Monday just didn’t seem sensible from a fundamental standpoint.^[ii] Moreover, far from being a currency war, it just seemed like Chinese policymakers were finally stepping back and letting the market react to a new tariff as it normally would: Strengthening the tariff-wielding nation’s currency in order to partially offset the tariff’s impact. See Econ 1 textbooks with any further questions. 

How’s That Brexit Stockpile Comin’ Along?

For months now, we have been warning that Brits’ stockpiling of various goods ahead of the original Brexit deadline, which was March 29 and risked being a no-deal Brexit until it was delayed at the 11^th hour, would weigh on output over the ensuing months as companies and households worked through their inventories. Tuesday’s Wall Street Journal had a fun update on those efforts, highlighting people’s quest to consume their stockpiled cheese, meat and milk before those pesky sell-by dates struck. Even those whose food rations were safely tinned and safe for the next year or two were dutifully whittling down their stockpiles, eating what they had on hand instead of buying much food.

This all got us thinking. Brexit is now scheduled to take place on Halloween. New Prime Minister Boris Johnson and his merry Brexit squad are jawboning endlessly about making this a no-deal Brexit, and EU leaders are now supposedly presuming this outcome. Hence, no-deal Brexit fears should be starting to crescendo once again. Thus one would think the no-deal Brexit hoarders wouldn’t be eating through their shelf-stable rations just yet.

Thus, we wonder: Has sentiment calmed down? Have people gradually realized the shops won’t be out of essentials come November 1? That a Brexit on World Trade Organization trade terms doesn’t stop trade between the UK and EU? That those delicious Continental sausages and cheeses will still grace the grocer’s deli? That toothpaste will not be rationed? Most of the folks interviewed in the Journal sort of suggested this was the case, with vague references to not feeling a need to stockpile before Halloween.

That makes us wonder if the corollary is true: Have investors more broadly also priced in that no-deal Brexit and moved on? Is the belief that a “nightmare scenario” won’t happen starting to gain steam? Is anyone but BoE chief Mark Carney still at their wits’ end? We guess only time will tell. And in the meantime, we will head on over to Amazon.co.uk to help the weak pound stimulate exports. 

How Government Reeling in the Raters Gave the Raters More Clout

This week in unintended consequences comes this: The Wall Street Journal reported that the US government’s attempts to reform the nationally recognized statistical ratings organizations—NRSROs, or credit-rating agencies—have backfired. Chief among these reforms was adding competition to Moody’s, Standard and Poor’s and Fitch. They did that: Kroll, DBRS and Morningstar are now in the mix. But:

The Journal’s analysis suggests a key regulatory remedy to improve rating quality—promoting competition—has backfired. The challengers tended to rate bonds higher than the major firms. Across most structured-finance segments, DBRS, Kroll and Morningstar were more likely to give higher grades than Moody’s, S&P and Fitch on the same bonds. Sometimes one firm called a security junk and another gave a triple-A rating deeming it supersafe.

We aren’t alone in the industry being unsurprised by this outcome. The government never fixed the core issue—bond issuers (outside sovereign governments) paid for their ratings. Bad! Bizarre. It meant even the new bond raters competed by offering great ratings at low low prices!

Now, to be clear: This wasn’t the cause of 2008. But it was a minor contributing factor. Hank Paulson was right to decline former French President Nicolas Sarkozy’s suggestion he blame all of 2008 on the raters.^[iii] It is also a smashing demonstration of government’s near-total inability to correctly perceive problems and fix them. A simple reform: eliminating the raters’ special regulatory status that requires banks and investors to use their “insight” and striking the pay-for-rating problem dead would have been simple. Yet here we are, a decade later, and none of that has happened. Nope, their “research” just led to more raters for folks to game. (Note: If we ever muse again, it will include a not-positive review of Firefighting by Ben Bernanke, Hank Paulson and Timothy Geithner.)

So Much for European Politics Being Boring in August

Maybe it was the sharp volatility, or maybe it is the fact that we Americans lack public holidays in August, but we sure needed a good laugh this week. We weren’t sure where we would get it, but we doubted it would come from European politicians. Not when they were all on vacation! Not when the always-entertaining Alexis Tsipras was no longer running Greece! And then came—wait for it—the great Matteo Salvini beach tour.

You see, three weeks ago, amid yet another public spat between the members of Italy’s populist coalition—the anti-establishment Five Star Movement (M5S) and far-right League—Italian President Sergio Mattarella ordered League leader Salvini to stop jawboning about a snap election and make up his mind. Commit, or pull the plug and get on with it.

So Salvini did what we like to do when we need to clear our heads and sort things out: He went to the beach. Only he didn’t wander a secluded shore at 6 AM, stare at the water in solitude and ponder life, as we are wont to do. No, he decided to tour the Adriatic Coast at the height of the summer tourist rush and make it a thing. As in a “Hey look at me I’m going on a beach tour let’s party!” kind of a thing.

Somehow, some way, it is working. You wouldn’t think parading around Italy’s beaches in bathing shorts, posing for shirtless selfies, spinning records at a nightclub (also shirtless) and posing with a wave runner (again shirtless, come on!) would be a surefire campaign strategy. But you would be wrong. As one politics professor explained to The Wall Street Journal, seeing a jolly politician be so secure in his dad-bod “makes people feel that he embodies them, that they are in government, in the system, through him. It’s a new form of representation.”

As more and more selfies popped up on Twitter, media attention mushroomed, and Salvini leaned in. Like any good politician, he took advantage. He held rallies. He publicized his itinerary. His vacation became a beachside disco-dancing whistle-stop tour! What better time to announce he was done with Five Star and ready to call new elections?

Now, entertaining as this all is, we hope it doesn’t start a trend. So here is some unsolicited advice for global politicians:

• Boris Johnson should not hold Brexit talks at a swim-up bar with Angela Merkel
• Joe Biden and Bernie Sanders should not debate Medicare for All on the Jersey Shore
• 2020 candidates should not hold a swimsuit competition (we might be ok with a dance-off, though)
• Shinzo Abe and Moon Jae-in should not settle their diplomatic spat with a jet ski race (again though, dance-off)
• Xi Jinping and Donald Trump should not settle their trade tiff with a weightlifting competition
• No one should rock anything more casual than a polo shirt and cargo shorts or a sundress
• (We would offer advice for Vladimir Putin, but that ship sailed long ago)

As for Italian politics and markets, we guess this is yet more evidence populism’s rise really means gridlock. So chalk up these beachside antics as yet one more reason to be bullish? 

Have a great weekend, and sorry for any mental images the above bullet points gave you!