The Punt For Red October

By Michael Every of Rabobank

The Punt For Red October

It was another red day in markets yesterday despite a positive start, as the post-Jackson Hole hangover continues to bite.

Stocks were lower, with the S&P -1.1%, carrying over into red Hong Kong and Nikkei futures this morning. Bonds were lower too: US 2-year Treasury yields were +3bp at 3.45% having tested up to 3.50%, and 10-years +1bp to 3.11% having been at 3.15%; German 2-year Bunds were +8bp to 1.14% and 10-years +3bp to 1.51%; and UK Gilts were little changed despite large swings, closing before former Chancellor and would-be PM Sunak warned that markets may lose faith in the UK economy. (GBP is the more likely channel than Gilts, one would think.)

In FX, CNY could not keep a foothold even despite another in a series of stronger-than-expected PBOC fixes. That a weakening currency cannot be ‘fixed’ even alongside a vast trade surplus that should be pushing it higher speaks to the upwards structural pressures on the US dollar, and the downwards ones on China and CNY.

Oil slumped around 5% after it became clear Iraq is not turning into the next Libya, and its oil output was not hit by recent unrest. (Although Iran, linked to the Iraq unrest, is playing hard to get with the nuclear deal again – presumably because of regional whispers that regardless of what Tehran does, President Biden has decided to sign the deal anyway, “because oil markets.”) Other commodities were also mostly lower on the day.

The broad-based sell-off was helped by German inflation rising 8.8% y-o-y and strong US data in the form of consumer confidence (103.2 vs. 98 consensus, with expectations 75.1, up from 65.6) and JOLTS job openings (11.2m vs. 10.4m consensus, or around two jobs going for everyone officially looking for work).

The last thing markets wanted to see was good economic news that would tip the Fed further towards another 75bps hike in September, let alone encourage its ‘higher for longer’ stance. If we get a US payrolls number that matches the consumer and JOLTS data on Friday, it will certainly back the punt for red October as well as red September.

Of course, it is not just the Fed’s bailout function that markets may lose faith in, nor just the UK economy. Indeed, combining the two, Stefan Koopman and myself just underlined the limited policy options available to *all* central banks as reflected in the possible external review of the Bank of England (BOE) presumed UK PM Truss may soon launch.

‘Bank of England Dreaming’ asks, “what is central bank inflation targeting good for?” given it only seems to work in a limited set of geopolitical and macroeconomic circumstances, which have now structurally changed. As such, we argue there are no policy framework tweaks that can help with the current backdrop. (And where I just heard a UK publican say beer needed to be £15 a pint to cover costs, but doesn’t dare raise prices; and a fish-and-chip shop owner say cod and chips is already £11 and will soon go up: given the minimum wage of £9.5 an hour, that’s potentially over 2.5 hours work, pre-tax, for traditional UK fare!)    

A further conclusion is that the only possible central bank policy answers are: 1) to assume geopolitics doesn’t exist, and so inflation goes back to 2% again – “because economics”; or 2) to look backwards to look forwards.

The BOE was specifically established to lend to the government for war against France, which in a zero-sum mercantilist world was seen as the route to greater flows of resources, and to macroeconomic stability. With regret, doesn’t that backdrop sound at least partly applicable to today’s geopolitical world, rather than forlornly saying “2%”? Indeed, back in 1694 the BOE was an early example of industrial policy in that England needed to build ships, requiring nails, etc., and to feed and arm its soldiers and sailors, all to help the flow of resources in its direction – and the policy *worked brilliantly*. As the same trick has for many others over history.

Of course, to aim for such ambitious and controversial policy and to fail, as so often seen during Covid, would likely accelerate the UK along the path to higher macroeconomic instability, greater socio-political alienation and polarisation, and more violent financial market volatility. The same is true for many other economies too: it’s a very high risk/very high reward strategy, and a very red October, and many more to come, could easily be seen. Then again, things are unravelling all over at the moment.

On which note, former Soviet President Mikhail Gorbachev just passed away at 91. A reviled figure in Russia for presiding over the collapse of the USSR, with all associated socio-economic and psycho-cultural woes, he will be held in fond memory in the West for having seen the peaceful end of the Cold War. Looking at current Western-Russian relations –as gas flows to France were cut again yesterday, and potential EU visa bans on Russians are floated– it’s hard to recall the heady days of the late 1980s, when US heavy metal bands strutted like rock gods in Moscow’s Luzhniki stadium to fist pumps and headbanging from Soviet soldiers.

Talking of heady early days –and mercantilism, industrial policy, and soldiers– Tuesday also saw Beijing announce the CCP’s key 20th Party Congress will take place on 16 October. The official announcement was replete with the official language heard back in the USSR in the late 1980s: “The congress will hold high the great banner of socialism with Chinese characteristics, uphold Marxism-Leninism, Mao Zedong Thought, Deng Xiaoping Theory, the Theory of Three Represents and the Scientific Outlook on Development, and thoroughly implement Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era.” Of course, the aforementioned terms are largely incomprehensible to 99% of Wall Street analysts covering Chinese assets. Yet how this news was portrayed in Chinese media led to immediate to-and-fro Kremlinology over what it implied for policy. Here is another hat to throw into that crowded ring.

The official text stated: “All Party members and people from all ethnic groups across the country will be mobilized to continue advancing the Five-Sphere Integrated Plan and the Four-Pronged Comprehensive Strategy in a coordinated manner, pushing forward common prosperity for all, advancing the great new project of Party building, and promoting the building of a community with a shared future for humanity.”

1. Common prosperity needs no introduction, even to Wall Street, and in 2022 is no longer taken to mean what it did when used in the reform period of 1978 (allowing some regions and groups to get rich first, then sharing their wealth). Markets now see it as closer to its first coinage in 1953, when it contrasted socialism with capitalism – “A road of a few getting rich, while the vast majority are poor and destitute.”
2. The community of a shared future for humanity is seen as linked to China’s more muscular foreign policy, which is challenging established western norms/hegemony. That, as the Solomon Islands will no longer allow Five Eyes nations’ navies to make port calls, and Australia and New Zealand begin negotiations over an economic and security deal with nearby Papua New Guinea.

In short, will we get a ‘pro-markets shift’, or a continuation of a more volatile policy trend? (As the annual US-China Business Council survey released yesterday, while still showing slightly more optimists than pessimists, also saw 83% of companies less optimistic than 3 years ago, and around a fifth having moved some operations out of China.)

Make up your mind, and then either do or don’t have the punt for Red October.