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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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It's all totally horrifying ..... but no big deal apparently, ref:- "Tail Risk" by Tommy Stubbington , The Financial Times, Companies and Markets

November 22, 2019

 

 

Rest easy .... we're not getting too UK-centric, it just looks that way at first. The truth is that Brexit chaos and the imminent general election that it has spawned make the UK the provider of many of the finest (which is to say, the most extreme) examples of modern day market peculiarities.

 

Yesterday saw the release of the Labour Party's election manifesto. Of course, everybody knows (one assumes) that this particular Labour Party leadership is of the "hard-left" variety ..... old-fashioned socialists for the most part, and arguably something stronger in places. So no one should have been surprised by the adoption of a radical agenda, but in the event the extent of the lurch further leftward came as a shock to some. Leaving aside the merit, practicality and economic effectiveness of such policies as wealth redistribution and hugely increased state control, as declarations of intent to TAX, BORROW and SPEND go, this was a doozy .... certainly by UK standards. It put some commentators in mind of the Labour policies of the 1970s, dark days for the UK economy. Others thought they were being too kind in their assessment, but then again it was never likely that a radical leftish agenda would find favour with most of the financial media.

 

Everyone will have their own view about these matters, but we can always rely on the market to take a cutthroat view on policies concentrating purely on their market effects irrespective of their political desirabilty (or otherwise). Or at least we used to be able to rely on such things, but no longer it seems. However much Messrs Corbyn and McDonnell intend to squeeze the wealthy (until the pips squeak ?), to fund their massive spending plans and four-day weeks etc it is inevitably going to require a huge amount of borrowing to pay for it. Huge government borrowing means , in the case of the UK, huge issuance of new UK Gilts. The prospect of such an increase in supply of these sovereign bonds should've, and would've in the past, caused a commensurate fall in prices  --  which of course means a rise in yields. And what happened yesterday ? To all intents and purposes, nothing .... nada ..... niente.  Gilt yields finished almost exactly where they started the day. In fact this morning they're considerably LOWER after poor output data, something gilt traders seem a lot more interested in.

 

The obvious explanation behind the lack of response of the gilt market to Labour's manifesto is that traders feel there is little or no chance of them coming to power. That would tally with the pollsters, but the pollsters have a poor, poor record in the UK of late and it's odd that there wasn't some reaction. There's something else going on here. After all, although their spending plans are nowhere near as extravagant as those of Labour, the Conservatives --  the pollsters' likely winners, remember  --  have left behind their aspirations to be known as the party of fiscal responsibility to make some pretty exravagant spending promises of their own, and the market didn't react to that either.

 

The new reality is that bond markets are not bothered about government deficits any longer. Away from the UK, and particularly in those countries whose debt is trading with a negative yield, investors are urging governments to borrow more to spend more. This of course is a function of the belief (realisation ?) that central banks are out of ammunition  --  monetary policy has gone just about as far as it can go, and it's time for fiscal stimulus to take over in the chase for higher growth, employment, inflation .... you name it. Investors are unconcerned about increased deficits and borrowing levels, even if they do threaten to cross Eurozone rules on such things. Let's face it, the authorities have never been exactly draconian in enforcing those rules even if they make noises about it from time to time .... like this week, in fact.

 

It's even possible that investor pressure may persuade Germany  --  yes, Germany  --  to abandon it's commitment to budget surpluses to allow fiscal stimulus to reinvigorate it's faltering economy. That's still a serious doubt while the powers-that-be declare that Germany's comparative malaise is an exports-related issue (due to trade conflict) ..... the domestic economy is running just fine, thank you. Maybe, but that's a position that ignores an undoubted need for infrastructure spending in Germany itself.

 

And what of the US ? We can be pretty certain that whoever runs in the presidential race, they will NOT be advocating austerity. If it comes to a run-off between a tax-cutting President Trump who also likes to spend a bit and a left-leaning Elizabeth Warren (say), the opposite will be the case and Treasury markets haven't reacted to that either.

 

The thinking behind it all is that of course theoretically increased bond issuance puts downward pressure on prices and upward pressure on yields, but issuance is only increased to provide the fiscal stimulus to growth that monetary policy no longer can, and therefore should be welcomed by investors. It won't suit short-term traders, but for longer-term investors higher yields engendered by solid growth is a good thing. Bond holders can live with that fine, unless the extreme possibilities of default or soaring inflation raise their ugly heads.

 

That brings Mr Stubbington back to the UK , which could end up being something of a test case. We can accept that bond markets can put up with a lot these days, including "a borrowing binge", but what happens if it's accompanied not only by high levels of total debt but by some form of economic meltdown brought on by a no-deal Brexit.

 

That's a question those in the UK might not want to know the answer to, but it's unlikely that investors would remain quite so sanguine as they seem to be right now.

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