Blame the Experts – that’s what usually happens when finance goes wrong!

Blain’s Morning Porridge – May 3^rd 2023: Blame the Experts – that’s what usually happens when finance goes wrong!

“I only said blow the blo*dy doors off.”

This morning: As Janet Yellen warns of default risk, and Jay Powell hikes rates, the risks to the global economy are mounting: a deflationary bust, or stagflation? Market confidence in the face of a deepening credit crunch is falling.

(Sorry for lack of comment y’day… One word: Trains. You know the rest.)

All generic disaster movies start with a frazzled expert.

She may be a marginalised official in some critical but largely ignored job, warning something horrible is going to happen, usually with an armful of graphs, printouts and charts that prove it. She is impolitely told to stop scaring the horses. Then the horrible thing happens. She gets the blame for not having prepared everyone for it, but struggles on to save the day before being hailed as a hero in the final reel! (Except in Earthquake (the 1970s epic) where Charlton Heston is swept away in a flood trying to save his wife as his mistress looks on… What message did it convey about the wages of sin and immorality…?)

Or it might be the police chief warning elected officials of the ravening monster, and unless they address it the town is doomed. But, you know the Amity beaches will stay open and the shark will feed on the paddling toddlers till he blows it up with a scuba tank.

Due to the convoluted dearth of responsibility and accountability in US politics, being blamed for the consequences of the coming US debt ceiling crisis is likely to be the fate of Janet Yellen, US Treasury Secretary, former Fed Head and generally respected economist. Jerome Powell, current Fed Head, will hike rates 25 bp later today, meaning he will be trolled remorselessly for his “utter incompetence” and putting the economy at risk. He will garner the opprobrium of Democrat leaders who “asked” him to ease up on tightening to boost the economy (ahead of an election year), but knows to ignore inflation would be a disaster, while surrendering on rates will just inflate greedy markets already betting when. He fears years of soft money has broken capitalism…

Yellen is frantically warning US legislators it’s vital they “act as soon as possible” – triggering a bond sell off and yield spike in one month T-Bills. The US may fail as early as June 1^st – a view backed up by other experts, although some think the Treasury may be able to smoke & mirror the debt limit crisis right through to mid-July. “Waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the USA”, wrote Yellen. (In Washington…. No one can hear you scream.. because no one is listening…. and they know best…)

If the US actually – or selectively – defaults on its debt….it will be an omnishambles. It will not be pretty. Even though it will be a technical default – and the US isn’t bust – you can’t be just a little bit dead. Its binary. Apparently, there are only 12 legislative days in May to find a solution before Yellen’s June 1^st. It will be a game of bluff, bluster and face… which side will blink?

“Default is not an option”, said Republican Speaker of the House, Kevin McCarthy while adding: “but neither are higher taxes, higher interest rates, continued dependency on China and an economy that doesn’t work for working Americans.” Democrats say the Republicans will throw the nation into recession and destroy its global reputation. Moody’s, the rating agency agrees: “it’s a long-term threat to growth. Financial markets and the economy will be hit hard.”

What happens if/when it happens?

Your guess as good as mine, but, perversely, I suspect not as cataclysmic a discrete moment as some folk fear. Markets will figure it’s only a matter of time before a new debt deal is hammered out. Traders may even interpret it as a “buy-the-fact” moment on the basis even politicians can’t be that stupid – rhetorical question. Someone will lose face – which will be significant in terms of the Biden vs Trump showdown next year. (!)

It’s all a bit silly. If the Republicans get their way, stopping the tax incentives proposed by Biden to promote domestic green energy manufacturing will stall the renewables fuelled growth we expected. That can only benefit China which will see its already dominant share of global clean power manufacturing enhanced. Another lose/lose for US politics…

However, in the wider context of the bursting everything bubble, a US debt default and the Fed continuing to fight inflation and hiking rates, has to be put alongside the rising fears of recession, higher for longer inflation (look at yesterday’s stronger than expected European numbers), plus the emerging credit crunch seizing the US and Europe. Yesterday’s soft markets highlight just how negative the market mood is, and the threat it tips into further downside.

There is not so much talk of an economic “soft-landing” anymore. Instead, market talk is polarising into how deep and what form the coming crash will take: a deflationary bust with a recession, or all-out stagflation! I suspect the latter. (Many of my colleagues disagree, pointing to crashing money supply as a signal of a deflationary event – but I fear inflation is going to prove incredibly stubborn as companies try to hike prices, while workers in tight labour markets demand pay hikes.)

While politicians will quite happily “cut their own nose off to spite their face”, (as my Granny would oft warn me), the real damage will be to market confidence. A debt default will be a further reinforcement of doubt in markets – and could plunge the US into a “Virtuous Sovereign Trinity crisis” whereby incompetent politics and a broken bond market break confidence in the dollar. Everyone is fearful what a dollar run may look like on the global economy and geopolitical games.

Don’t expect stocks to remain the bright point. My colleague Julian Wheeler pointed out 70% of the S&P 500’s upside this year comes from just 5 stocks he’s named GAMMN: Google, Apple, Meta, Microsoft and NVIDIA. The Amazon bubble burst some time ago, and it’s clear Cathie Wood’s deranged imagining of Tesla at $7 trillion is a not-ever-going-to-happen play. The rest of the market is a sideshow. When the bubble bursts, who wants caught in the blast radius?

All good banks are alike, but each bad bank is bad in its own way…. 

Closely linked to the US debt risk is banking. First Republic was a fire-sale purchase for JP Morgan early doors Monday morning – an inevitable quietus that will undoubtedly reap Jamie Dimon’s bank more than the $500mm per annum it’s trying to frame as its likely long-term gains from the deal. Fire-sale prices represent opportunity: JPM is the biggest bank on the block, has the cheapest funding, gets access to clients and resettable mortgage assets… What’s not to like? But even JPM’s stock price slid yesterday.

However, the question to be asking is not if First Republic is the end of the mini-banking crisis, but: which second tier US bank will be next? The FT cites investors warning about “aftershocks”. The sharks are circling other names.

JP Morgan’s Dimon, and others would like us to think it’s all over. But, the world has changed. Thus far the government has facilitated the buy-out rescues, made the required promises about deposit guarantees, and looked ready to intervene, but there has not yet really been insurmountable, challenging crisis. What happens when its 3 or 4 banks are all struggling together, the treasury is mired in Government shutdown, Trump is leading the polls, Europe is sliding into recession and the Chinese are rattling sabres?

Markets have become “hypersensitive” to the risks of further banking downside – any signs of stress in weakened bank names will quickly become apparent and spread. That’s when the current crisis becomes CRISIS. Bank leaders will be trying to move on the gawkers, but the smart bank analysts will be asking questions and trying to discern what comes next, including:

• Asset quality – what surprises are hidden in what look to be sound mortgage books, commercial property lending, or consumer loans? What has been missed? (Funny how KPMG has audited all the bust banks.. just saying…)
• Interest sensitivity – not just on lending, but on assets and how impaired they may become in a market event.
• Twittersphere velocity – the speed at which rumours become the facts has been extraordinary and will remain excessively elevated in hypersensitive markets.
• Management – how aware are the bosses of the multiple crises of confidence and banks, and the alternative places to put money, and how experienced are they to fight the intangibles that are likely to come their way? (When a bank recruits a CRO from an auditor rather than the market – what does that tell us?)

I don’t accept Silicon Valley, Signature and First Republic are the only names suckered by the fool’s paradise of low rates and never foresaw the consequences of rate hikes and consumer demand for returns. There are bodies still to bloat and float to the surface of the swamp….

It could yet become a FUBAR moment of monumental proportions. Spice up the risks of recession and persistent inflation with a deepening and self-reinforcing credit doom loop. Already its clear a major credit crunch is developing – that becomes inevitable as the restriction in lending deepens the effect of the likely recession, causing banks to further rein in lending, further deepening the credit crunch… Return to start, do not collect £200. 

There is a lot to unravel in the current market.

Meanwhile, long ago in a galaxy far, far away….

The UK second quarter GDP figures are going to be shocking after a spate of May bank holidays and the entire productive capacity of the nation tied up in bunting and celebration coronation mug production. Tish and nonsense I say. The train to London y’day was packed with sightseers – a very keen lady told me she was going to “walk the route” to “pick her spot” to stand and watch the Coronation of King Charles the Third this weekend.

I am trying to stay aloof from the nonsense of it all. I shall tell anyone daring to invite me to coronation street party to boil themselves in their own Coronation Savoury Tartlet (it is not a quiche say the French). What is British about a quiche???? When since did the coronation of a new unelected leader involve a celebration dish? (Asparagus is far too good to be cooked – it’s the start of the Season: lightly steamed, some butter, lemon and parmesan is perfect.) Why could we not have chosen something we all agree is definitionally British? Like a Coronation Chicken Tikka?

I am not an ardent monarchist, but neither am I a rabid republican. I happen to agree with King Charles’ perspectives on the planet, but otherwise our lives are a different as chalk and a lead paddleboard. If the benefits to the UK’s soft power from monarchy are greater than the inherent risks of it embarrassing us, then I’m happy to go with the flummery of it all. Who is not inspired by the pageantry and history? Or is it all about the power of really good PR, marketing nous, and news management.

God Save the King I say, but I will hedge myself passing my glass over a jug of water wondering if somewhere in Poland there is a Sosiebski-Stuart with a solid claim to the Throne… (Ye Jacobites by name….)

Five Things to Read This Morning

FT        Three failed US Banks had one thing in common: KPMG

FT        Hindenburg attack is uncomfortable reading for Icahn’s most loyal friends…

BBerg  Nigeria Targeted a UK mansion; it’s next leader’s son now owns it

WSJ     Why is Inflation So Sticky? It Could Be Corporate Profits

Guardian         Pearson shares fall after US digital learning rival says AI hurting its business

Out of time, and time for the day job..

Bill Blain

Strategist – Shard Capital