“It’s A Wacky Race To The Bottom… And The US Is Losing Badly”

Submitted by Michael Every of Rabobank

Wacky races to the bottom

In monetary policy terms, this is now clearly a race to the bottom. The Fed have cut twice, and Evans’s comments from yesterday aside, are expected to cut far more (we say to zero); the ECB have reintroduced QE already, at EUR20bn a month for now; the BOJ are expected to stir at this month’s meeting; the PBOC are pledging to do what they can to get rates lower for firms; the RBNZ surprised a while back with a 50bp cut; and the RBA cut 25bp again to 0.75% yesterday, partly on the basis that ‘everyone else is doing it so how can we not?’ Moreover, that’s just a sample of broader trend to slash rates, which also runs right across emerging markets too.

Crucially, the US is losing this race, and badly. The Fed is hardly a leader in this rate cycle, and more likely to be a laggard as things stand. Cue yet more withering commentary from US President Trump about that relative lack of action and the impact it is having on the USD. Meanwhile, EUR and AUD, for example, are heading downwards at a pace that their respective central banks will be quite pleased about. Just don’t call it a race to the bottom, because that triggers nasty memories of periods of history that markets and politicians don’t like to recall.

In no way a coincidence, it’s also a race to the bottom in manufacturing PMIs. Over in the workshop of the world, China is at 49.8, which is bad; Japan at 48.9; South Korea at 48.0; and only India at 51.4 and booming Vietnam at 50.5. In Europe we have Germany at 41.7, which is shocking and heading towards June 2009 lows, and the UK at 48.3. Even Russia, isolated and proud, is at 46.3! And now in the US we have an ISM print of 47.8, meaning that even the US manufacturing sector is slumping (although Markit printed at a healthier 50.9). Yes, there are a few pockets of growth, but the general picture of a synchronised downturn in manufacturing across the global economy. Which is of course why we are going to see rates slashed and a race to the bottom in currencies; and that deflationary effect is going to reinforce the need to slash rates.

That’s all worrying enough. But then you have to ask two other questions.

First, is industry going to drag the services economic down, or can we all live on lattes and haircuts alone? (Or, more accurately, on housing markets and apps?) For now, it appears we can – otherwise this would be a global recession already. However, the historical track record is not good on that front. If we are going to start shedding manufacturing jobs globally, and not just in the West, that is going to knock demand for goods and for services, absent further consumer borrowing…and aren’t we close to being tapped out on that front? Or to painting ourselves into a corner if we do?

Second, how long until we get a sufficiently robust policy response? We know that there is much muttering of fiscal policy being used, and even of Modern Monetary Theory (MMT). Indeed, an interesting aside is that on a recent visit to see financial European clients, everyone was immediately familiar with the term MMT when in previous years this was not always the case. However, seeing the logical inevitability of the need for a new radical policy is one thing. Actually seeing it put in place in a way that helps the global economy is another. That’s because we seem to be on a race to the bottom in terms of politics as well.

Starting with Asia again, we can probably rely on China–which just celebrated the PRC’s 70th birthday in North-Korean-meets-Busby-Berkley extravaganza with a chorus-line of glittery nuclear missiles, even as Hong Kong saw serious unrest–to put in place more stimulus. In fact that’s a given. What isn’t a given is that this will sit alongside a stable CNY as capital flight is still evident in the balance of payments data. Moreover, stimulus to date is either not working or is being ring-fenced for the home market unless you sell raw materials: how else can one have an economy growing nearly 6% y/y in real terms and yet see flat or deeply negative y/y import growth from a swathe of countries, not just the US? Likewise, the track record says if the BOJ acts again that will mean a weaker JPY not a stronger market for foreign goods; the same is true for South Korea; and the rest of Asia just doesn’t offer enough heft to matter much, relatively.

In Europe, can we really expect self-flagellating hair-shirt governments to push for MMT when they have found it so incredibly hard to move the needle on any fiscal stimulus at all, even as populism raises its head across the continent? In particular, will Chancellor Merkel, in her twilight, suddenly reverse years of hoarding and instead start splurging…knowing that the splurge will be spent across Europe and not on German goods? Really? And even if Berlin does go that route, will it not see EUR fall and European net exports pick up anyway, meaning Europe is exporting global over-capacity rather than absorbing it? Europe would need to splurge globally to help matters globally, and that is just not on the cards.

The UK does appear to be about to embrace gun and butter and anything not nailed down fiscal activism under this new Tory administration…but then again it isn’t actually in power while it is in office, so talk is cheap; and given PM Johnson’s latest Irish backstop proposals, which are a major concession, are still being described by EU sources as being as palatable as “a bucket of cold sick”, we are soon going to get either a Hard Brexit that will hit the global economy harder, or a new caretaker rebel administration just to delay Brexit that will have no political ability to stimulate the economy at all. Excelsior!

And then we come to the US. President Trump has obvious proclivities towards spending vast amounts of money and taxing as little as possible, and the US is, despite popular misconception, still propping up global demand from everyone except China (which as noted, looks and smells mercantilist – and yet gets none of the public opprobrium for such). Yet the US political environment is once again focused on trying to impeach the president, or on stopping that happening. Grand economic schemes are not generally dreamed up in this kind of environment, and even if Trump were to pull one out of a hat, it seems highly unlikely Congress would want to give him the win when much of it is going for the kill (with “deep sadness”).

In short, it’s a wacky race to the bottom in races to the bottom. Choose yourself who is the Dick Dastardly in it all (Trump?); the Mutley (John Bolton?); the Rufus, Ruffcut, and Buzzsaw (populist voters?); the Peter Perfect (Biden?!); the Penelope Pitstop (Merkel?); the Luke and Blubber Bear (the rest of the EU?); the Ant Hill Mob (Australia?); the Professor Pat Pending (central banks?); and the Gruesome Twosome (China and Russia?). But it doesn’t matter who wins because as things stand we are all losing.

And as such it is any wonder bond yields are starting to go that route again,…and that the USD is still holding its footing? US 10-year yields, and indeed most 10s, are still far above recent lows even if they are also above recent highs.