Blain’s Morning Porridge – March 18^th 2024: Will Central Banks ever ease interest rates and why rush?

Interest rates are more than just numbers, or control rods for inflation – they set the parameters of financial common-sense.

It’s a big week for Central Banks: the BOJ on Tuesday, The Fed on Wednesday and the BoE on Thursday… but none of them are set to ease rates (the BoJ might even hike). It’s a very different market to what traders expected earlier this year. This is becoming the Year of Normalisation.

But first… The 2024 Six Nations Rugby Championship played out as expected over the final day on Saturday. Ireland won. Scotland came second despite underperforming, and losing 2 games they should have won. But the real stars were Italy – they won two matches, but should have won against France and England – which would have put them near the top. Mrs Blain is unhappy as Wales take home the Wooden Spoon.

Italy is doing rather well these days – not only in Rugby, but Italian bond yields have tightened to Germany on the basis the country is doing better on a relative basis. When I was there a few weeks ago in the Aosta Valley, there was a mini-boom underway driven by money out of the Rich North. May be time for a deeper dive on Italy? Any thoughts appreciated.

Back in the real world.. its all about rates..

I want to start with two quotes from the FT, from an Unhedged interview with Aswath Damodaran, the efficient markets professor: “Investing is an act of faith”

• “I’m going to say something that’s going to sound weird: a market with a T-Bond rate of 4% is much healthier than a market with a T-Bond rate of 1.5%. People don’t feel the urge to do stupid things..
• “The fact that the T-bond rate is 4 per cent is a good sign for the markets and for the economy. All this talk about “when will the Fed lower rates?” completely misses the point. This is where we ought to be.”

Hooray! Common sense! I could not agree with Damodaran more. (Read the article – he makes some very clear points about markets and Nvidia.) I’ve been saying the same things for decades – ultra low rates are dangerous and have multiple consequences on economic behaviours. Real interest rates should not only remain a least a percentage point over inflation – at least – but should reflect the lessons we learnt about the causes of financial insanity during the QE era of monetary distortion.

We I get round to writing my not-very definitive history of 2 decades of real silly market ideas…  everything from CDPOs, Crypto, Meme-Stocks, Reddit boards, NFTs, RC, Tesla and the multiple investment themes that blew away like summer hars… at the centre of it all will be the question, what were central bankers thinking about interest rate policies..? Did they realise what ultra-low rates do to markets and investment behaviours?

Yep… low rates for a sustained period of time are a terrible idea… Except…

The Japanese economy is very well behaved, dull, predictable and very boring. Yet is has trockled on with negative interest rates for decades with the Bank of Japan now owning most of all financial assets. Cut interest rates to zero in the west and a speculative frenzy causes prices to head stratospheric. Not so in Japan where its’ taken 34 years of low, low rates for the Nikkei to climb past levels last seen in 1990 despite interest rates barely troubling whole numbers.

This week, that will likely change as the BoJ is expected to raise interest rates to the dizzy height of 0%… which, to be honest, does not sound like a carry-trade killer. Borrow in yen at zero-rates and the yen will likely continue to depreciate…. Or will it? Will it cause ructions in the bond markets and drive the Yen to new fervid heights? Lots of people seem to think so.

Brace yourself for the inevitable disappointment. Japan remains work in progress – it could take years for the attempts to change corporate behaviours and culture to work through. What is potentially more interesting is the scale of wage increases just agreed with the major unions and how these could drive consumption, or will it go into yet more savings?

Behavioural scientists struggle with Japan markets….

The Fed meeting this week is going to be more…. immediately significant. Earlier this year markets confidently expected a series of swift Fed eases to take bonds back into the 2% range by the summer, triggering a massive stock bloom and riches for bond traders. Now, these views have moderated. Rates are now expected to decline a modest 75 basis points by year end – and I find myself wondering why when the economy feels robust, resilient and strong, and the last inflation print (last week) was subtly high.

Although the inflation watchers are still earnestly watching the stars for clues about wage inflation and energy-price-spikes, they don’t seem to grasp the concept of “Sticky”. Last week we also saw “stagflation” creep back into the financial comment-sphere with the possibility of slowdown suddenly stalling the economy while inflation and rates remains high and stubborn.

Maybe everything in the US economy is not so rosy. I suspect there is more economic pain to come for the US – while I argue strongly for higher interest rates to discipline corporate and investment behaviours, the effects of mounting debt on consumer consumption, confidence, and costs (including rents and housing) can’t be underestimated. (Unhappy consumers make their views felt at the ballot box – hence the success of Trump and MAGA.) The debt levels that have been run up by consumers on credit cards and auto-loans in the US are much more scary than the government debt quantum.

US government debt – which by agreement of the financial press oversight board must now always accompanied by the modifier “unsustainable” US government debt quantum… (the bond vigilantes insist on it.) Relax, the US is not going to go bust.. they own the keys to the dollar printing presses… they can keep printing money to repay creditors… nothing to worry about… except:

• Dollar collapse on the debt quantum – bond yields have to rise
• Running out of buyers at current rates – bond yields have to rise
• US politicians doing something really stupid, (not a zero-sum probability) – bond yields have to rise, massively

Meanwhile the Bank of England is unlikely to do anything hasty with UK rates until later this year… I am told they are going to get all the data out, jumble it up a bit, have a cup of tea, and then think again about what it all might mean so maybe have a clue what’s happening by the time summer comes around. In Europe, the ECB’s Pablo Hernandez de Cos said over the weekend “June could be a good date to start”, if macroeconomic forecasts are met. Market conditions may be “compatible” with 2% inflation being met, but that is central bank speak for … maybe, maybe not.

The big issue for central banks is the future future, rather than the future markets think about (ie 5 mins). Sustained sticky inflation is one way to get rid of growth, especially if the economy is also growing… The key thing is rates are not coming down soon or fast. That should have the equity markets… thinking…

Out of time and back to the day job…

Bill Blain

Strategist, Author of the Morning Porridge

Wind Shift Capital