The Odd Decouple

By Michael Every of Rabobank

The Odd Decouple

Yesterday saw Fed-dy bears return to the site of the picnic massacre with Sriracha sauce and take out those cocky sandwiches. Despite Fed Chair Powell making clear that US rates are going nowhere for years and years, 10-year US yields went up past 1.75% before consolidating to just below 1.71%: a month ago we were at 1.30%. Once again, this helped push equities lower, and tech stocks in particular. Moreover, it happened despite a spike in US jobless claims to 770,000 (though admittedly the Philly Fed ran very hot), an Ohio auto factory saying it would ship all its jobs to Mexico, and oil prices gapping sharply lower. Whatever happens today, if the Fed thought just jawboning would be enough, *it’s* a sandwich short of a picnic.

Above and beyond the march higher in US longer yields, it’s crucial to underline the central-bank decoupling going on: the ECB just increased its bond buying; the RBA are refusing to hike for years; the Fed are sitting on their hands for years too; the BOE are as well; and the BOJ are today expected to formally make the policy shift of only buying equities when they go down, not whether they go up or down – this is tightening? The closest we see to real hawkishness in the developed world is Norway’s central bank, which has brought forward expectations for what will probably be the West’s first rate hike: it now expects to start in the “latter half” of this year.

Meanwhile the RBNZ has to find a way to permanently keep house prices under control while not raising rates, with Kiwi Q4 GDP -1.0% q/q and -0.9% y/y despite beating Covid. As argued here before, this underlines the issue with the Western monetary-policy/socio-economic structure. A colleague repeated to me the anecdote that ‘using interest rates to control the housing market is like using a shotgun on a mosquito’; I countered that NOT using rates –or anything at all– to control the housing market is like giving the mosquitoes shotguns.

By contrast with the West, emerging market central banks are hiking/tightening. China is, if not via rates; Brazil just hiked 75bp; Turkey a massive 200bp; and the Central Bank of Russia meets today. This policy decoupling isn’t related to the impact of the virus: China and the EU aside, western economies are doing better on vaccines and recoveries – look at the “no yachts left behind” gold rush in Australia (though retail sales were -1.1% vs. 0.6% expected in February). So are emerging markets doing this for fun?!

The optimistic (market) view is the West needs ultra-low rates for fiscal-monetary fusion so it can Build Back Better, and that Western central banks are fully in control and there is no inflation risk; and the pessimistic view is the West needs ultra-low rates to Build Back Bubbles —which the West is allowed to live by, but emerging markets (mostly!) are not— and Western central banks are *not* in control and there is a global inflation risk. Emerging markets can see this game.

On a related note, it’s no surprise the US-China meeting in Alaska went badly. Rather than the de-escalatory tone floated by Zhongnanhai-whisperers, the US started with a lecture on human rights, Hong Kong, Taiwan, and cyberattacks: Secretary of State Blinken even claimed Chinese actions “threaten the rules-based order,” and that “the alternative…is a world in which might makes right and winner takes all, and that would be a far more violent and unstable world.” Cameras were sent out of the room as things got heated, then brought back in so the Chinese side could be recorded saying: “Is this the way you hoped to conduct this dialogue? I think we thought too well of the United States. The United States isn’t qualified to speak to China from a position of strength.”

Perhaps the market only pays attention when that most political of crosses, USD/CNY moves. Yet consider that if the US seems very happy for USD to move lower, and China is tightening, the White House will not be thrilled to see CNY remaining as stable as it is at the moment: they will want it stronger – not the weaker level of around 6.70 many Chinese firms would like to see as a resting place.

It’s also not just the US in the firing line. The EU’s symbolic sanctions on China introduced this week –the first for three decades from a bloc that clearly does not want to pick a side– produced this official vitriol via Twitter: “If the EU makes erroneous decisions based solely on the lies of ill-intentioned anti-China forces, then it shows clearly that this is nothing but political manipulation. Should the EU insist on taking wrong actions detrimental to Chinese interests, we will react with a firm hand.” Even diplomatic European spines might be stiffened rather than softened by that tone.

In short, there still seems to be the odd decoupling left to be done. More so as Russia’s President Putin responded to US President Biden dubbing him a “killer” with a challenge to an online public debate: it would be great TV, but I am just not sure how to allocate the roles of Walter Matthau and Jack Lemon. At the same time, North Korea is no longer even interested in contact with the US; and Saudi Arabia is on the outs long before Iran is in on any new deal.

It’s a good job markets are too busy to focus on any of this because of a rise in US yields as we all Build Back Bubbles.