And so, after four months of enforced idleness thanks to the vengeful nature of my former employer – I’m back in a chair, poring over my screens to once again try and make sense of the world. I’ve been fortunate enough to move to Singapore, and if any readers know smart, curious and friendly folks out here I should be connecting with please do take the time to tell me who they are. A couple of weeks back I wrote a quick summary of how I thought things might have gone during my time off – and wanted to check back in to see how I did!
Firstly, what seems clear is that there is one main show in town. If one compares M3 growth to nominal GDP growth across the major economies, not one is growing faster than the 5y average. Global monetary conditions are tightening across the board. The biggest deflators, relatively, are the US and Australia. Both have money growth slower than NGDP growth – so are tightening both relatively and absolutely. My first expectation was that the market would be anticipating the Fed tightening to the point of recession, but despite the selloff in equity markets in october – the picture post mid terms is much rosier than I expected in the market’s collective mind. The curve is steeper – implying a more orderly tightening. Equity markets are recovering, albeit not as quickly as many would like. However if you talk to people they will earnestly tell you they are expecting recession and slowdown in 2019/20 – and indeed some of the big american banks have made this call with JP Morgan calling for a recession in 2020. To me, the market seems ripe for this narrative to be picked up in the new year – and so the current pricing of interest rates seems far too agressive. The peak of the forwards curve is at 3.40 in the US and I would expect that to come down to just above 3% in an economically bearish scenario. The theatre of Democrats subpoenaing Trump acolytes left right and centre might provide a catalyst for that, as might the prospect of a government shutdown. Moderates did not do well in the mid terms – so Democrats ought to be spoiling for a budget fight.
The other big potential catalyst is Australia -where the combination of central bank complacency and housing market weakness remains a powerful driver. Still the most deflationary monetary environment in the developed markets, and with an outsized financial sector (40% of the stock market!) – Australia is the prime candidate for a financial market induced slowdown. US rates are probably the better play – and option structures that would do well from Australia => US contagion look more attractive than piling into the already well received Australian interest rate market to me. I think that broadly speaking I got this one right – and receivers of Australian rates have been well enough rewarded -especially if done vs USD.
As regards Europe, the view from this side of the world is cloudy. Spreads remain wide and every day brings news of further tensions between the Italian Government and the European institutions. However, all of this still looks to be a red herring. What matters is ECB policy – and no matter what constraints are there legally and practically to keeping an insolvent Italy in the zone through monetary chicanery – the baseline assumption has to be that the ECB will find a way. It is, institutionally, one of the worlds most independent and powerful central banks. In a fight between it and the current government, I would take the ECB every time.
FOR THE RATES MARKET PROS: A neat tactical play for near term worries is provided by a previous bit of ECB intervention. A large chunk of TLRTO money (loans the ECB made to eurozone banks at highly preferential rates) becomes too short for banks to rely on it to goose their NSFR (net stable funding ratios) in the new year – so they will either have to issue paper, borrow in wholesale markets, or the ECB will have to step up again. In its current hawkish messaging – the latter is less likely. Paying Bobl spreads here looks a good way to position for eurozone breakup fears and benefit from the coming rush of banks to the market. If anyone wants to tell me I’m wrong because of seasonality, or because the bobl future is too rich on the curve then I would love to hear it!
FOR THE NORMAL PEOPLE: The big story of global financial retrenchment is going to be the big story in 2019. Most people are carrying around a model in their heads that says that money was ample for the last 5 years but mysteriously the market didn’t respond. We know they’re wrong. Monetary aggregates have been growing at their normal pace – despite central bank action. The world has moved from a normal environment to a tight monetary environment – and that is going to be the backdrop for markets in 2019. Expect many surprising bearish events – from EM panics to esoteric parts of the developed financial markets blowing up – as $ become scarce everywhere.