Rabobank: “What The Market Should Be Focusing On Is Whether There Are Still Markets”

Submitted by Michael Every of Rabobank

As COVID-19 continues to spread worldwide, economies slump, stocks of personal protective equipment and key drugs dwindle in the US, and as Americans buy record numbers of guns, the market focus today is arguably going to be on one thing:

How high is the spike in US initial jobless claims going to be this week? Last Thursday saw a staggering 3.3 million figure, far worse than what were already shocking consensus figures, and producing the kind of chart that many observers presumed must have been a mistake. It wasn’t – and this time round the expectation is 3.7 million newly jobless.

Yet there is a further claim to be made today: what the market should be focusing on is whether there are still markets.

To put it another way, how much and how rapidly are Western economies going to look like their Chinese counterpart (which is not recognized as a market economy)?

On a surface level we already see lockdowns, and state drones in the sky monitoring people to see what they are doing, virus-wise; or intelligence agencies using mobile phone monitoring to see where people have been, again to track the virus spread and infection risk. Yet those are arguably just to fight the virus itself.

Economically and financially we can also see that we are about to face fiscal deficits of 10-20% of GDP with no prospect of that debt being dealt with the ‘traditional way’ and repaid (which overlooks the fact that financial repression and de facto default is actually the traditional way and arguably more effective for economic development if the state is spending the money right).

We are already used to zero rates in the West – which are lower than in China by the way. We are used to an alphabetti spaghetti of different central bank mechanisms to try –and largely fail– to force liquidity into the parts of the productive economy that actually need it as opposed to the bloated and/or extractive and/or low productivity zombies that really don’t.

We now have yield curve control too: sovereign bond yields are going to be where they need to be. So while any part of the curve that central banks don’t control yet can still go wild for now, that will just end up with the central banks extending their powers to it too eventually. The price will be what they want it to be.

We know that equity markets can still go down, but that authorities won’t allow this to last for long without stepping in with support of some kind. “Because markets.” That might even mean nationalisation in some cases; or slush funds and bail outs for firms who squandered all their free cash flow on dividends and executive bonuses in others.

We know that credit is now going to be channelled by the Treasury and central bank in the USD trillions to companies large and small – and it will be political decisions rather than market ones as to which then make it through this crisis – and afterwards. As a result, SMEs will be saved – and tied ever-more closely to the whims of the state; and big companies will either end up serving the state directly (to produce ventilators, for example) or dependent on its ongoing largesse, which will no doubt also come with a social quid pro quo.

Then we have trade, where everyone is going to become more protectionist as they stimulate in order to keep that precious liquidity at home; and against Eurodollar liquidity pressures it could easily be outright mercantilism in an “All of your dollars is belong to me” kind of way.

Even on oil, imagine if the US were to impose tariffs on foreign energy imports at the equivalent of USD40 a barrel. This would immediately place a market floor at that level, while US shale, after being saved at that price, would provide an energy cap of around USD50. These are rough, hypothetical figures: yet as the US suggests Russia and the Saudis and itself need to find common energy ground, could we also be looking at a future oil ‘market’ that is also channelled into a narrow range that suits the state best?

For now we still have FX, the ‘terrible twos’ of the financial markets: extreme mood swings, and no idea of what it is doing even as it is doing it. In short, hard to control. It seems unlikely we are going to get capital controls in the West, or a new Breton Woods era of FX stability – for now. But if FX is allowed to play the role of honest broker – selling off sharply when a country decides to repress all its government bond yields at artificially low levels, for example, or saves low productivity industries at high cost, then perhaps it would be politically useful to enforce naptime on this toddler too. China has done its level best to stop the FX market functioning as it should via various mechanisms – and talking about USD/CNY is not the same as talking about EUR/USD! (Yet regular readers will know we believe that unless the rest of the world climbs on board with a new global currency compact, CNY is heading one way: down.)

And we have one more key Rubicon ahead for the West that runs parallel to the US jobless claims figure: where do they draw the line?

In the face of an unprecedented economic downturn, Western governments are doing their best to ease the pain. However, what are they going to allow to fail? Perhaps nobody can fail – as France’s Macron has publicly promised. Good luck with that and keeping a market economy. Yet who or what can be allowed to let go without starting a domino effect that threatens the broader system and shaky confidence? Don’t ask China, because they have no clear idea. We will shortly find out if market economies still do – or if we still do market economies.