Home Tickled “Are We To Be Tickled Under The Chin Or Punched In The...

“Are We To Be Tickled Under The Chin Or Punched In The Face For The Rest Of The Week?”


Submitted by Michael Every of Rabobank

Idealists vs. realists

Monday, markets were punched in the face. Tuesday, they were tickled under the chin. Yesterday they were punched in the face and then tickled under the chin.

Following a weaker CNY fixing and rate cuts from the RBNZ, Bank of Thailand, and Reserve Bank of India, the punch was quite expected: indeed, at one point US 10-year yields were as low as 1.59%. The recession warning from the curve that was sent was so powerful that one really should not ignore it. As such, the tickle was unexpected: yet in one of those bouts of US exceptionalism that has some waving the Stars & Stripes and others muttering about the Plunge Protection Team, US Treasury yields round-tripped back up to 1.71%, and equities decided this was the time to rally.

So are we to be tickled or punched for the rest of the week? Consider the evidence:

  • German industrial production collapsed 1.5% m/m and 5.2% y/y in June. This is pre-Hard Brexit;
  • The editor of China’s Global Times has tweeted: “Washington’s repeated bullying has made it meaningless to continue trade talks in short run. China is mobilizing internally to fight firmly with the US, and all official media is participating in the mobilization. China and the US are caught in a stalemate worse than last round
  • A Fox news correspondent has also tweeted: “Chinese Trade Sources tell us that China expects 10% tariffs on an additional $300 billion will be added Sept 1st. Those sources also say China expects that 10% to go to 25% because China will stand firm and not buy US Agriculture”; and
  • India and Pakistan appear to seeing a full military clash on their disputed Kashmir border.

Perhaps the market can shrug off a clash between two nuclear powers – we already saw a similar threat a few months ago even if in reality it seems far less damage was done then than claimed. “Nukes, shmukes”. However, yesterday we shifted our base-case scenario for US-China trade relations to full escalation (see US-China trade war update: No turning back), which the news today supports. That is likely to matter more than nukes to our trade-obsessed markets.

Indeed, CNY fixing this morning was 7.0039 so even though it was well below the close yesterday of 7.0602 we have finally seen a fixing over 7 for the first time since 2008.

Nonetheless, there still appear to be two camps out there: not so much bulls vs. bears as idealists vs. realists. Consider the words of the head of the German cybersecurity agency talking about Huawei, which can be summarised as: “It doesn’t matter if 5G components come from China or Sweden. If political trust alone is the basis for investment decisions, we destroy the global division of labour and our prosperity. There is no qualitative difference between China and the US.” In short, the head of cybersecurity of a key NATO member is so wedded to a free-trade theory with more holes in it than Swiss cheese–intellectually and in terms of actual protectionism–that he is prepared to ignore cybersecurity.

By contrast, the US has just banned not just Huawei but five Chinese tech firms from selling goods to the government or anyone taking government money effective next week. Even in Australia, where every politician seems to have “house” tattooed on one set of knuckles and “trade” on the other, the chair of parliament’s security and intelligence committee has publicly warned “The next decade will test our democratic values, our economy, our alliances and our security like no other time in Australian history,” adding “We keep using our own categories to understand [China’s] actions, such as its motivations for building ports and roads, rather than those used by the Chinese Communist Party,” drawing comparisons to how many Western intellectuals fawned over Stalin, and concluding “choices will be made for us” if there is no Australian action, and “Our sovereignty, our freedoms, will be diminished.”

Frankly, if you fall in the realist camp then you expect developments like Japan-South Korea trade relations breaking down; India-Pakistan clashes; and full-on US-China Cold War. As a result you are still expecting far lower bond yields, and after a lag, lower equities. You are also expecting USD to power ahead, along with JPY; and you realise central banks are going to end up serving political goals.

By contrast, if you fall in the idealist camp (“I’ve never been there but the brochure looks nice”) then our worrying backdrop is all just random nonsense that appeared out of the blue and everyone needs to realize free trade holds the answers to absolutely everything, while central banks can and should and will remain independent (just as they haven’t for most of their recorded history). Of course, equities will go up–they must!–and then rates will go up too without any problems. Ironically, central banks will also bail everyone out regardless if there are any problems, so there isn’t quite as much implied love for free markets as one might think.

Which camp are you in?