Rabo: There Is A Lot More Happening Than Just Movement In 10-Year Yields

By Michael Every of Rabobank

Forests, Trees, and Bonsais

Yesterday this daily mentioned the current strategic theme that the Roaring 20s is a rotten comparison with the 2020s if you are an optimist. This isn’t the first thematic trading idea that has called out market optimism as wrong using logic and historical hindsight. Allow me to recap:

• In 2014, ‘Asset-Rich, Income-Poor’ looked at income and wealth inequality, the underlying drivers of it via globalisation and financialisation (a strategic theme our Rates Strategy Team has also long fully embraced), and suggested this would start to have a real-world impact sooner than blissfully-QE-d to the eyeballs markets realised. It was an early call, but “inequality” is now ubiquitous, politically and in markets;

• In early 2015, ‘FX Wars’ looked at the history of shifts in FX policy under various economic systems and concluded we were likely to see a shift towards the use of QE outside the US, and subsequent FX swings. The ECB announced its QE plans a month later, and EURUSD subsequently dropped from 1.20 to a low of 1.05;

• In early 2016, ‘Thin Ice’ argued the global liberal order was far weaker than it appeared: the ice it stood on was a mile wide but only an inch deep, and once it broke, things would not be the same again – deglobalisation would begin. Brexit and Trump both won that year, blind-siding markets;

• In late 2017, ‘On Your Marx’ projected the US and China were almost certainly heading for a new Cold War, which would involve tariffs and the threat of the USD as weapon, pushing CNY lower and trade-flows outside China. That call speaks for itself even if CNY is trading strongly again at time of writing;

• In 2018, ‘The Rise and Fall and Rise of the Great Powers (and Great Currencies)’ looked at the lessons of economic history and grand strategy for an emerging multipolar world order, concluding the US would follow a naval-based ‘Mahan’ strategy in the Indo-Pacific, slash interest rates (below China’s), embrace a fiscal deficit not prudence, and shift towards more protectionism/rebuilding its industrial supply-chains. Such tactics are clearly being adopted, if stop-start;

• In 2019, it was ‘The Age of Rage’, arguing populism would surge on the left and right to co-opt central banks into becoming more political. Obviously there was no prediction of Covid-19 as a driver of all this – but here we are today regardless; and

• Last year, in the chaos of Covid, there was ‘The Next Normal’, pondering what the next economic principle governing it ‘–ism’ or ‘–ism’t’ going to be, asking if capitalism was still the appropriate label for it given the structural shifts underway, and noting that we don’t know yet.

One can say there is only one argument through this all: yes, but then again, some economists base an entire career on one, far simpler idea that isn’t even true. The key point is that throughout, some in markets keep saying ‘it won’t happen to me’. They are looking at the trees and not seeing the nasty forest. Yet the forest doesn’t care if you don’t see it or not.

Bloomberg reports, US Secretary of State Blinken just gave a speech on China in which he stated it presents “the biggest geopolitical test of the 21st century”; that the US relationship will be “competitive when it should be, collaborative where it can be, and adversarial where it must be”; that China is “the only country with the economic, diplomatic, military, and technological power to seriously challenge the stable and open international system”; and that shoring up democracy around the world is “a foreign policy imperative”. Meanwhile, the New York Times carries a recently-translated speech from Xi Jinping in which he states “The East is Rising”, and “the US is the biggest threat to our country’s security and development”. One can focus on the fact US 10-year yields went up again yesterday, and wonder if central banks will act; or one can see geopolitics will necessitate central bank curve crushing – and more beyond.

Yet many key players are still looking at trees – or even bonsais. Just as US legislation that would ban Chinese companies already cited by the Commerce and Defence departments from raising capital in the US, was reintroduced yesterday, Bloomberg simultaneously reports “The rivalry between the US and China means that investors can no longer afford to leave Chinese assets out of their portfolios,” according to the world’s largest wealth manager. Add them to a Wall Street list including several billionaires, one quoted saying “As both countries test their power and influence in the coming years, investors should build portfolios resilient enough to withstand all possible outcomes.” Well, of course! But to do means understanding how these things work! Only now recognizing a global power-struggle is happening…and the response being to ‘diversify’ between two rival blocs, which grand –not market– strategy, argues will logically decouple, strikes one as ‘banzai!’ as much as bonsai.

Meanwhile, the Dutch semiconductor giant ASML announced a USD1.2bn sale of chip-making equipment to China’s SMIC, a firm that is on the US entity list banning tech sales to it. While the White House is quoted as saying this is not an issue because they are focused on the next generation of technology, it underlines how hard the US will need to push others to maintain its lists and red lines; and widening EU-US fault lines – and the risks they widen further. Of course, one can also point a finger at the US: the White House is still using Zoom for its meetings, despite concerns this is a security risk. That speaks volumes about the US disconnect between its China hawks, China doves, and those who just think bonsais are neat to look at.

To reiterate, there is a lot more happening than just movement in US 10-year yields. Those matter a lot right now: but they will ultimately be driven by larger geostrategic themes more than short-term moves in the price of gardening tools. Indeed, they will be driven rather than themselves being the driver – at least for the key players. ‘We wanted a Cold War but the bond market said No’, is not a headline the global hegemon will see written: the FX market, perhaps – but even that No would not come without far larger volatility in lots of physical markets first.

But back to the trees/bonsai. The Fed’s Beige Book showed the US economy expanded modestly over the six weeks ended mid-February. Business contacts were optimistic about the rest of 2021 as vaccines are rolled out, but at the moment things were only getting better slowly. On inflation, some retailers and manufacturers were able to raise prices, but many others were not, which jars with the supply-chain meltdowns being flagged in the ISM manufacturing survey this week.

Aussie trade data saw exports up 6%, imports -2% and a bumper surplus of AUD10,142, while retail sales were 0.5% m/m vs. 0.6% expected. So all good there, it seems. The Aussie bond market is still waiting for the RBA to do whatever it takes: and the RBA is still saying “Whatever”. Its bond operation announcement today saw the usual AUD2bn purchases, not more, and no yield curve target yet. No surprise given how slow to react the RBA always are, perhaps, but something will have to give soon as Aussie 10s blast up towards 1.80% again (nearly 15bp higher in three days): the thematic thinking above still suggests it will be the market, not central bank control. I ‘leaf’ it to you to decide how to play it though