Rabobank: Yesterday’s “Reflation!” Trade Appears To Be Old-Fashioned Glue-Sniffing

By Michael Every of Rabobank

Re: Reflation

As we all know, markets can remain irrational longer than you can stay solvent, and they are encouraged to do so when monetary and fiscal authorities encourage them to sniff solvent. However, yesterday’s “reflation!” trade appears to be old-fashioned glue-sniffing without any help from the central banks or governments. A 13bp leap in US 10-year yields, with a steepening curve, a surge in US stocks, and a dumping of both the US dollar and gold all coincided with the following monetary backdrop:

The Fed saying it will be taking away $20bn in QE in tranches by Xmas, and likely hiking 25bp in 2022, before doing 75bp a year from 2023 onwards; the BOE “opening the door” (says Bloomberg) to a rate hike as soon as November – see here from Stefan Koopman; Norway hiking 25bp, the first in the G10 to do so “post”-Covid; the RBNZ suggesting they will follow suite next month; and Reuters quoting 8 ECB governing council members who all appear to be hawkish. Only the PBOC was playing the usual game this week in terms of net liquidity injections.

And it was doing that because in the actual economy / fiscal backdrop, the Wall Street Journal reports local governments have been told to prepare for Evergrande to fail. This is taken as bullish by some because it means China is being proactive: then again, so is the firm being “saved” by being broken into three and nationalised, another story doing the rounds, which implies losses for bond and equity holders, and a new economic model. Chinese local governments actually rely on land sales to the likes of Evergrande for 30-40% of their income, so who is going to step in to stop them failing? We know the assumed answer, but do we know the unassumed impact on the exchange rate? It isn’t reflationary – at least outside of China.

Likewise, on reflation and failing, in the US there appears no sign of the Democrats being able to find a majority to pass either a stop-gap spending bill, or an increase in the debt ceiling, or the infrastructure bill, or the $3.5 trillion stimulus bill. Indeed, a headline says the US is preparing for a government shutdown. We are used to shutdowns now, but that does not smell reflationary.

In the UK, the government is to cut GBP20 a week from the pockets of the very poorest, who are guaranteed to spend, not save it, and hike taxes on everyone else, just as energy prices surge, and shelves threaten to empty of products, including staple foods. The same energy and supply-chain backdrop threatens the EU too; and the US, where we not only have a record 73-ship backlog in LA/LB ports, but the

Biden administration is threatening to use the Cold War Defence Act to force firms to release information on their holdings of semiconductors. The aim is to prevent hoarding – but what happens when each firm says “None; none; none; none; none”?

This move potentially opens the door for the US to use the same Act to force production home by fiat, upending global trade patterns and shipping – and markets. But will it really be that radical on the current track record? And would that make any difference in the near term anyway given new chip fabs are already breaking ground, but will take years to come on line? It’s everything else, from widgets to thingamajigs that the US needs. As does everyone else, of course.

On balance, perhaps it is the central banks and governments / politicians who have their heads in a plastic bag. Not only in thinking now is the time to tighten fiscal and monetary policy, but in their studied inability to understand that the supply-chain issue is the real underlying problem.

Looser fiscal policy won’t help unless it is aimed at resolving supply-chain snarls, which is a geoeconomic and geopolitical issue; but tighter fiscal policy also won’t help, while making socioeconomic matters far worse.

Likewise, hike rates all you want and it won’t help supply-chains, but it will break lots of other things; but loose monetary policy won’t help either unless it is supporting governments in building more resilient, distributed, and localized supply chains.

For all the talk of the new understanding of “fiscal and monetary fusion”, and “Build Back Better”, there is still no sign apparatchiks in central banks or treasury departments / finance ministries understand this fact. They remain collectively irrational long enough for everyone else to become insolvent.

There is also a strong odor of adhesive from some banks, as Bloomberg Daybreak says “Therapy, Puppies Ease Bankers Back to the Office”. Therapy – for going back to the office? Puppies?! Lovely – until they grow into big dogs. “Yeah, I will have that price for you in a second…down, Spot!…I am just getting it now…Spot! Down! No, I don’t mean spot is down, sorry. I mean….Spot! Stop biting the other trader!” Or are the puppies abandoned as soon as they are no longer useful – and who cleans up their mess? Which are two questions one also wants to ask when, just as predicted earlier this week, Bloomberg says a certain large US financial firm “Targets China Tech Billions” in a new ETF.

Meanwhile, nobody seems to hold any Evergrande foreign debt that may now be defaulting after missing a coupon payment yesterday, and starting a 30-day grace period countdown. Nobody. The firm clearly sold all those bonds to itself. And Chinese junk-rated dollar bond issuers were already back in the market yesterday as the “Evergrande to fail” headline hit: even junk-rated property developers. All “Reflation!”, and no “Re: reflation…”

Then again, in the face of a global pandemic and a socioeconomic body-blow, the US saw household net wealth increase $5,849bn in Q2 alone. Almost six trillion dollars. In three months. When supply chains were collapsing and the labor market wasn’t doing that much laboring. It takes a LOT of glue to hold that kind of number together, trust me.

Oh, just give me the puppy and be done with it. You can clean up your own mess when the time comes.

Happy Friday.