The jury is still out, but I reckon that last week’s price action provided a foundation for markets to finally get an answer to the question that’s on everyone’s mind. The sustained climb in equities, and precipitous decline in the dollar, are interesting in their own right, but am keeping my eyes on the US bond market. The long bonds sold off steadily through the week, a move that culminated with Friday’s curveball of a NFP report—payrolls rose by 2.5M breezing past the consensus of a 7.5M fall—and a further leap in yields. All told, the US 10y rose by almost 30bp last week, to just under 0.9%, and with the front-end more-or-less locked, the 2s10s and 2s5s steepened to 70bp and 30bp, respectively, which is the widest since early 2018. A closer look at the chart won’t really raise any eyebrows. Sure, the curve is steepening, but it’s not like the move is unprecedented, and the curve is still overall quite flat. In the present context, however, last week’s move is a clarion call to the Fed. Will they allow (long-end) bond yields to reflect the deluge of debt issuance, and associated economic rebound, or will they, as some have suggested, put the Treasury market on a “war footing” via a yield cap? In other words, it’s do or die for the decision on yield curve control. Of course, that’s not entirely true. The Fed has been waffling on this issue for ages, and there is no guarantee that they won’t continue to do just that. That said, I have to say that last week’s squeeze in bonds offers a very tasty and clear setup for this week’s FOMC meeting. Will the Fed let long yields run or will they put a lid on them, either verbally, or via an outright YCC announcement?
Read MoreI have a lot of sympathy for pen-wielding strategists at the moment. Every day the empty white sheet of digital paper is staring at them, the little cursor tauntingly flickering in the top-left corner. The most obvious course of action, to copy-paste their previous note, is just about the only thing they can’t do. We economists at least have a steady flow of new data, however mundane and useless, to write about. In other words, the main questions remain the same, and they remain largely unanswered. Economic activity has collapsed, and is now staging what appears to be a painfully slow rebound. Even in the best of worlds, however, it’s difficult to escape the notion that significant damage has been wrought in on both the demand and supply-side. This puts equities on the spot. A reflexive rebound from the nadir in March was always coming, but could it be sustained, and would we re-test the lows? In a normal recession the answer to those questions would be “no” and “yes”, but there is nothing normal about this recession. U.S. equities have roared higher, and the ubiquitous growth stocks, which outperformed before, are leading the charge again. The S&P 500 growth index is up a cool 32% from its March lows, and is now flat year-to-date. By contrast, the S&P value index is up “just” 21% from the lows, and are still carrying a 20% loss year-to-date.
Read MoreMany investors understandably remain focused on the rally in equities, probably with a mix of satisfaction and astonishment. As interesting as the virus-defying rise in equities is, though, the real story this week has been in U.S. rates, Let me explain. It started with analysts suddenly remembering that trying to shield the economy from the Covid-19 induced lockdowns is going to cost money. Markets’ memory was stirred by the U.S. Treasury announcing that it is planning to place $3T worth of debt in Q2 alone, a cool 14% of GDP, and that’s probably just the beginning. The initial response by many analysts was to extrapolate to a depreciation of the dollar. After all, that’s an awful lot of currency that Uncle Sam will need to produce, assuming that is, that the Fed is going to stand up and be counted. As I argued in my day-job, that reaction was surprising to me. After all, it’s not as if European governments won’t have to dig deep either, and it’s not clear to me that the race to throw money at Covid-19 favours a bet against the dollar. In any case, before we get to currencies, the incoming tsunami of U.S. debt issuance is also, obviously, important for fixed income, and in a world of uncertainty, I am happy to report that the movie currently on offer is one that we have seen before.
Read MoreThe idea of government intervention and demand-side fiscal stimulus was born by Keynes, eradicated by neoclassical economics, lazily reintroduced by the new Keynesians, and is now enjoying a renaissance. It’s fiendishly difficult to judge history in real time, but I would bet that the current shift has momentum, a position that has been strengthened by the response to the Covid-19 crisis. It is perhaps unfair to insist on a marriage between this story and MMT, but it serves as an introduction to the issues at hand. The idea that governments with sovereign Chartalist currencies can’t run out of money, and that this power should be used to achieve full employment, is enticing. It is also, however, naive. MMT easily dodges the main theoretical critique, at least in the current environment. The Phillips Curve probably still exists, but it has also flattened significantly, making it difficult to attack MMT armed with the traditional trade-off between unemployment and inflation. If MMT passes this first test, however, it fails the subsequent trials. The implementation of MMT in today’s economy requires significant shifts in the relationship between fiscal and monetary policymakers and an end to the free flow of capital. My sense is that about half the proponents of the theory don’t have a clue about any of this. The other half understands that MMT requires an end to central bank independence, and a significant reduction in capital mobility. The problem is that this latter group aren’t being honest, and for that reason, I am skeptical about their true motivation. If you want to dial back globalization, the least you can do is to be honest about what this means for households and firms. If you think that an independent central bank is a suboptimal institution, how will the alternative look, and how will it be held accountable?
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