Two things have become clear, thanks to the slightly spicy English of Mario Draghi. To set the stage, it’s October 26th, 2017, and we wait for the latest announcement from the ECB. US 10s are near recent high yields, breaching the tough resistance of 2.40%. The Euro has come off the boil, and stocks everywhere are near the highs. Out comes the text, and Mario does not disappoint, hitting all his lines right on cue. Rates will remain low; however, the ECB will slow down asset purchases, in a measured way, starting next year. Then comes the press conference, and he confidently walks it back. Yes, the economy is doing well, but if we don’t see some inflation, we are fully prepared to hit the gas again. Boom. Bonds and Bunds rally, rates fall, Euro gets creamed, stocks take off. And the two things are….
- Central bankers and politicians are scared witless (a good rhyme). They have inflated an asset bubble, and they know it. The Fed has raised 4 times, and financial conditions have eased. After the ECB, Portugal 2s went negative. Portugal! Sweden is growing at 4% and the forward curve has negative short rates 2 years out. A replay of the mid 2000s, where the entire economics trade focused on wages and inflation, and completely missed asset prices. Holy Minsky. Trump jumps out of character and goes milquetoast on the Fed chair. Petrified of a collapse.
- It will be ridiculously difficult to trade. Yes, it won’t end pretty (Dudley just put in his walking papers at the NY Fed – does he not want to be around for the fireworks). But if we get tax reform that includes a major cut in corporate taxes, the rally is likely to continue. I point out that the FAANG stocks have outperformed an already red-hot S&P by 25% over the last year. Despite two straight quarters of improved growth, unemployment at generational lows, surging global PMI data, rates cannot rise. This past Friday, we got a reasonably strong jobs report, with the exception of wages, great survey data, fabulous cap goods orders and strong productivity growth. Everything acted like rates went up – Euro fell, gold fell, EM FX fell hard – except they didn’t. Maddening.
As Yogi may have said, it’s tough to make sense of things when things don’t make sense.