Blain’s Morning Porridge – Oct 25th 2023: Uncertain markets in uncertain times..

“This castle hath a pleasant seat. The air nimbly and sweetly recommends itself upon our gentle senses..”

Volatility in Treasury markets is setting off Global alarms. Economic numbers and earnings present a mixed picture of what’s occurring in terms of rates and inflation projections, but the reality is markets are highly vulnerable to rising uncertainty!

Let me start by apologising for late comment this morning, and lack of commentary y’day. Blame it on alarm clocks – She-who-is-Mrs-Blain woke me at 5.15 am to catch the very early train y’day. After I showered and shaved, I put my watch on and realised it was only 2.20 am – her alarm was mis-set! As a result, I was like a half-shut knife all day! Today? Suffering from a surfeit of cheese.

I should not have eaten so much cheese before carving the Turnip-Lantern last night. Nicky and her chums were polishing up their Nimbus 2000s for the big night – and some cheese and wine appeared. We’re having our god-kids for dinner this weekend, (and she hasn’t decided how to cook them yet…) Only joking.. but the house is full of sticky, sweet Halloween treats to fatten-them-up keep them happy.

Let me pose a question: have we entered a recession and just not spotted it yet admist the current noise?

Halloween is a good time to try to discern the future. Its when the curtains between worlds are thin – it is a time of drama. That’s kind of apt given the current market. Looking at events and prices this morning, all I can suggest is Act 1, Scene 1 of the Scottish Play:

“When shall we three meet again, In thunder, lightning, or in rain?

“When the hurlyburly’s done, When the battle’s lost and won…..

“Fair is foul and foul is fair, hover through the fog and filthy air.

Or in terms current market participants may recognise:

• In bond markets there is truth – but how confused, contradictory, and grim is that truth at present?
• What is being told to us by turmoil and tumult in energy, inflation, rates and market sentiment?
• What is the noise hiding from us? (Reality?)
• Or is it politics, where the malicious Sprite of a President Past squats over the prospective wrack, ruin and shutdown of a nation, its currency, its bond market while setting free a plague of global instability?
• As Kings, Emperors, Presidents and other Vagabonds set upon each other, how unstable the world doth seem…

Yep… way, way too much cheese last night..

What next? The unexpected?

“Hail to thee, Thane of Glamis!”

“Hail to thee, Thane of Cawdor!”

“Hail, Macbeth, that shalt be king hereafter..”

Suffice to say, the Tragedy of Macbeth does not end well for anyone…

This morning I’m still trying to figure out this week’s wild swings in the 10-year Bond: a 20 bp range over just a few days, mean. 5% is just a number – but one of great portent, say the bond watchers. Nope. It’s just a number. 6% is another number – and one should probably frighten us more. I remain fearful the market is not really comprehending the lagging effects of rising rates on the economy.

The big question is: what does the Fed think? A resilient US economy and inflation showing too few signs its beaten, means there is limited incentive on them to ease rates. That means higher for longer – and yet more lagging effects and negative consequences building up within the economy. In contrast, if central banks were to start easing rates tomorrow, it could be next June before we see any stimulus effects of lower rates on activity in the economy.

Central bankers are hoping they’ve anticipated all the delays and consequences of lag – but it’s like trying to land a jumbo jet blind, and knowing it takes 8 months for any jiggle of the throttles or joystick to have any discernible effect. 8 months is a long-time for over-levered corporates to struggle on with double digit corporate borrowing, for consumers to keep up 30% payments on maxed-out credit card balances (these balances are up 30% since the pandemic), or keep buying new or second hand cars by borrowing yet more at higher rates at a time when real incomes are not keeping up with inflation.

It feels like something has to give.. The prospects look high for recession in Europe and the UK, and marginally less so in the USA. Witness Bill Ackman declaring his Treasury shorts closed on the basis the US is headed for recession and Fed easing in nailed on.. his timing as the 10-year yield tumbled 20bp looked… smart. The secret of great comedy and tragedy is the same……..          timing. How smart will Ackman look by Christmas I wonder?

Is there a moment when it becomes suddenly become clear consumers can consume no more, and the great corporate unfold is underway? The reality is such moments never occur – a whole global corporate sector does not collapse together – the firms within it fail on a bell-curve measuring their survivability over time. Funnily enough, the market is currently still talking about the “resilience” of the US economy, when it really means how well companies are coping with the “adversity” of higher interest rates, rising wage demands, higher energy costs, and still fractured global supply chains. I suspect the market is not seeing the forest for the trees – which of course is what happened to Macbeth when Birnam Wood marched on High Dunsinane! Lay on McDuff indeed…

The global economy is not a story of mass events, but of individual, usually unobserved, discrete economic triumphs and tragedies. Economists look at the markets, events and try to describe how they function in terms of the curve averages. Investors buy risk on the basis of how diversified and granular it is. The media and news focus on big drama, They don’t focus much on tales of individual bankruptcies or small enterprises going bust. Market players controlling billions place their bets on headlines around a massive oil acquisition in the Permian basin as a signal of growth, but miss the unfolding economic unravel going on all around them!

The current volatility in US bonds suggests increasing uncertainty at the core of the global financial system – investors are supposed to understand how the most important “risk-free” asset reflects the prospects across economic activity. But, at the moment it doesn’t feel that way. Stock pickers are still looking at growth in tech and ignoring how overbought a PE of 17 times looks in an economy that may already be in downturn – although this morning a sell-off looks in prospect. US bonds are showing themselves friable and vulnerable to the peculiar madness of crowds. I suspect stock pickers are forgetting it’s the rate on bonds that sets the relative value of stocks!

Are rates going higher of lower?

That still depends on inflation – where the key issue will remain global energy prices, which are vulnerable to conflict in Europe and the Middle East. Is the yield curve normalising (which seasoned Fed-Watchers say is a portent of imminent recession after a steep inversion), or does the sudden re-inversion tell us something unknown about current market risks? Markets, analysts, and economist can deal with, and understand, known factors such as what the numbers are telling us about the future path of inflation, corporate earnings, consumption, consumer spending vs savings and make educated predictions about the costs of energy – but at present, these clues have never been so dark, or felt so uncertain.

Are rates about to decline? We are now seeing the lagging effects of the swift tightening by central banks impact economies. Unemployment numbers are beginning to nudge higher. Wage demands remain vocal, but will ease as jobs become more precarious. Central bankers are high-fiving themselves over falling inflation signals – but its unwise to suggest that falling food prices immediately after the harvest means they stay that way longer-term. The smart rate-setters know its Energy prices – Gas to power Europe and Petrol to keep the global economy rolling – that is critical.

Meanwhile, could something cause this all to unravel even faster?

I am fascinated by what’s occurring in the US. Donald J Trump casts a lonely figure in the courts, ranting, raving and cursing the judges who have the temerity to think they might judge him. His followers and lackies are cutting plea bargains and deals. He curses them some more. The American intelligentsia are appalled – they know the world is watching and fear what they are thinking. Yet, in Congress the forces of Trump, Maga and Populism have made the country look ungovernable.

Relax. Its Political Theatre. of course it is.. The US won’t allow the govt to stop, to shutdown, to present ultimate weakness in the face of global pressure and the mounting challenges from Iran, Russia and China. Of course they won’t…. The Democrats will cut a deal..

Wont they?… won’t they??      ?

Five things to worry about this morning..

FT                   Republicans select fourth Speaker nominee after Trump Torpedoes Emmer Bid

BBerg              The Last Time US Yields Rose So Much, It Sank The Economy Twice

FT                   Hipgnosis Board under pressure as music pioneer faces crucial vote

WSJ                Weapons Flood Israel’s West Bank, Fuelling Fears of New Front

Guardian         UK Financial regulators scrap cap on banker bonuses

Out of time, and wondering how to finish the Halloween lantern..

Bill Blain

Market Strategist