Rabo: Cooperation or Conflict

Market comments

Market comments

Markets were closed in the United States yesterday for the Juneteenth holiday.Consequently, European markets took centre stage,and wasted no time in selling off sharply.The EuroStoxx and FTSE indices were down by three quarters of a percentage point,and the DAX off by almost a full 1%.10-year gilts added 8bps and the 2-year note added almost 14bps as the market braced itself for a consumer inflation report today,and a Bank of England rates decision later in the week.German bunds showed a little more resilience by only adding4bps to 2-year yields.

It seems to have been a case of sell (almost) everything and buy the Dollar on Monday. The DXY was up0.27%, but despite the stronger Dollar,Bitcoin inexplicably rose by 0.93%. If there was any lingering conviction about crypto’s value as a high-beta risk proxy,this move should dispel it. The correlation between Bitcoin and the Nasdaq has been in free fall since the end of last year.

But fear not, Wall Street being closed for the day doesn’t mean that nothing happened! USSecretary of State Anthony Blinken was in China for talks with Xi Xinping. Joe Biden was upbeat, saying that Blinken “did a hell of a job”while he was over there, adding that “we’re on the right trail here.”Xi was positive too, noting that the two countries were making “progress”. There are two types of progress,though. You can have big progress,or you can have little progress. Blinken was keen to point out that the two countries had agreed to setup a working group to reduce the flow of opiates and fentanyl to the United States. That’s great, but Director of the CCP’s Foreign Affairs Commission Wang Yi cut through the bonhomie by warning that China had “no room to compromise or concede”on the Taiwan issue, and that the United States needed to choose between “cooperation or conflict”in its dealings with China.Little progress it is.

Speaking of little progress, ECBVice President Luis de Guindos yesterday suggested that core inflation is going to remain stubborn in the Eurozone, even as headline inflation continues to fall. We’ve heard this story before, but it bears repeating. There was no consensus amongst other ECB speakers on what this might mean for policy rates. Torch-bearer for the softly-softly approach, Philip Lane, said that a hike in July was probable, but that there was no need for the ECB to commit itself to raising rates further in September. He noted that the ECB will do another forecasting round before then, and that it would make sense toget a look at the flow of data before the ECB starts painting itself into a corner. Isabel Schnabel was having none of that. She took the Teutonic approach by saying that the ECB should “err on the side of doing too much, rather than too little.”Schnabel may be right to jawbone rates higher before European fund managers and traders clear off for ‘Cucumber Time’(I love that phrase). The weather has been too good,and generally not conducive to firm control of growth in the money supply.

However, there is more than one way to skin a cat!Fed Chair Jerome Powell has been suggesting for some time now that the Fed wouldn’t have to go as hard on rate hikes because the banking system would provide some endogenous credit tightening following the recent bank collapses.This may be the case in Europe,too. The Financial Times this morning carries a story on UBS facing “hundreds of millions of dollars in penalties”over Credit Suisse’s handling of the Archegos Capital saga. Regular readers will recall that Archegos was the hedge fund managed by Reddit fan-favourite and leverage enthusiast Bill Hwang,which ultimately imploded and left its bankers nursing heavy losses. Alongwithan ill-fated relationship with Greensill Capital, Archegos was one of the episodes that tarnished Credit Suisse’s previously sterling reputation sufficient to see a loss of confidence amongst the depositor base that ultimately resulted in Swiss regulators forcing UBS to acquire its long-time rival, like it or lump it. So,Credit Suisse was wrapped up in a parcel and handed to UBS shareholders, but the parcel was ticking!

The banking crisis news flow has died down, but it hasn’t gone away. It really can’t go away while the conditions that led to the collapses and the wobbles in the UK pension system last September (during the Liz Truss fever dream)are not only still present, but actually intensifying. I wrote yesterday on the market’s hawkish outlook for the Bank of England this week and in the months ahead. The Wall Street Journal today echoes our view that inflation in the developed world is going to be a persistent nuisance, and that central banks face a Sophie’s Choice of potential policy errors with Isabel Schnabel’s “erring on the side of doing too much” (i.e. recession) on one side, and letting inflation run out of control Arthur Burns-style on the other.Who would be a central banker?

For the time being, developed economy central banks are cooperating on tightening the screws on global credit growth.But this is breeding conflict with elected governments, the developing world and over leveraged households. Cooperation or conflict might be the dichotomy in international diplomacy, but for monetary policy, we choose both.