By Michael Every of Rabobank
As I keep repeating, it’s still all politics; and also all about the parting of the ways.
President Trump is – as usual – insisting that he did nothing wrong in giving his 6 January speech and won’t be resigning or be 25th-d. Perhaps legally: but the great diplomat Talleyrand summed it up best, “It was worse than a crime. It was a mistake.” And politically it was a huge error, given the collapse in his approval rating across the board.
Republican Senate leader Mitch McConnell is happy to press ahead with impeachment: and if you don’t think that will trigger a Brexit-style civil war in the party you haven’t been following Brexit. Which kind of Republican Party will eventually emerge, Mitch’s or Trump’s?
The departing Trump administration has declassified a foreign-policy strategy document 30-years early(!), which underlines its stance towards China. ABC news Australia notes this was previously classified “secret” and “not for foreign nationals”. It reveals the US Indo-Pacific strategy was heavily influenced by both Australia and Japan, and was not forced on them. It also commits the US to “devise and implement a defence strategy capable of, but not limited to: (1) denying China sustained air and sea dominance inside the ‘first island chain’ in a conflict; (2) defending the first island chain nations, including Taiwan; and (3) dominating all domains outside the first island chain“. To say that this will not go down well with China, or that China will not be happy that Australia and Japan helped drive this, is an understatement.
Of course, we now have the Biden administration: will there be a reversal of the parting of the ways? Consider the following Axios story, which certainly shows just how near the two have been up until now: “President-elect Joe Biden’s inaugural committee will refund a donation from former Senator Barbara Boxer after the California Democrat registered as a foreign agent for a Chinese surveillance firm accused of abetting the country’s mass internment of Uighur Muslims.”
A hop, skip, and a jump away in Europe, the German press (@wiwo) also have an exclusive on the EU-China CAI investment deal (which we will be publishing a more detailed report on soon). For those who cynically thought the rush to seal the deal was about the looming end of the German EU presidency or the Merkel chancellorship, think again: the claim is Germany has been offered a side-deal and “China is willing to provide Deutsche Telekom a mobile phone license, which would a first for a foreign company,” and that in five years DT might even be able to own such infrastructure – with the quid pro quo being that Germany opens its national network to China Mobile. Once this story sinks in across the EU, will there be a parting of the ways between Germany and everyone else? And once it sinks in across the Atlantic, will there be a parting of the ways between the EU and the US? This does not look as much like “strategic autonomy” as it does old fashioned Merkel-cantilism. Many US (and EU) voices say these are generational national security issues that go far beyond any one firm, and are instead about epoch- and paradigm- shifting geostrategy. But rather they aren’t – und das ist das problem.
So to another parting of the ways: the 10-year US yield from the 2-year, as the curve keeps steepening. This is a major market development – but is it really sustainable? We have seen repeated mini-cycles of this attempt at steepening before – and each time they end up with a flatter curve and a lower base for that flatness.
Has anything fundamentally changed in the structure of a US economy that sees little productive capital investment and lots of frothy frivolous financialisation, and little real wage growth and lots of asset-price inflation? Did labour suddenly win vs. capital and nobody told me? Did I miss the revolution? Yes, the Biden administration offers a fresh perspective and the President Elect has talked about the need for further trillions in stimulus. However, with the slim majority in the House and the Senate, and especially after listening to Senator Manchin, it would surely be a more realistic view to assume that what we will see is not “Workers of the world, unite!” but rather “Woke-rs of the world, unite!”: in other words, an economic policy that is highly progressive but not old-school leftist. That is not going to be inflationary, if so.
Apparently the latest curve steepening is being led by markets listening to Fed muttering about when and how it might start tapering QE. This as the virus rages further (and even Germany flags its lockdown might need to last another TEN WEEKS!); and this as we all know how tapering worked out for a far –less damaged US economy last time round. One would think that Janet Yellen would remember that. Of course, we also have to add what our Rates Strategy team has to keep explaining: when the Fed tapers, bond yields go DOWN not UP. By removing financial froth at a time when there is no productive capital investment or wage growth you take money out of the economy, and that is deflationary, not inflationary. The exception would be if Treasuries are now like certain EU bonds, where there is a huge bid provided the central bank backs them, and hardly a bid if they don’t. Is that really true for the US? Hardly.
For FX markets, the issue then becomes how high US yields have to rise before people might start taking a real interest in USD again. Logically, there is a big difference between higher yields driven by expectations of higher US rates, which would likely smash EM FX, and higher yields driven by concerns over the US fiscal/debt outlook, which makes the USD look more like an EM FX. We are nowhere near the Fed hiking; but we are apparently somewhere near the Fed tapering –at least in the market’s imagination– and surely that withdrawal of USD liquidity would again smash EM FX? That’s what we saw back in 2013 anyway. Let’s try to be consistent even if we are also wrong. Surely we are also a long way from markets treating the USD like an EM FX though – because if not, what does that make EM?
Today does of course have US CPI data to look for, expected 0.4% m/m and 1.3% y/y, and 1.6% y/y core. Now there is a reason to be bearish USD if you want one when one contrasts those prints with the near-deflation being experienced in Europe and Japan and China. That’s the kind of parting of the ways you get between economies relying on domestic demand/consumption and those relying more on investment and/or net exporting to that consuming economy.
So, yes, we likely won’t get a trend reversal FX parting of the ways until other economies cut rates further or do more QE; or US rates rise again or the Fed tapers; or the geopolitics changes as the US consumer of last resort tries to ring-fence any new liquidity for itself alone, which Trumpism leaned towards via tariffs and sanctions, etc., and Bidenism might continue via “Buy American”… or might not.
On which, it’s back to watching US politics, which rather than the parting of the ways shows that there is actually something in common to all that is going on.