Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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October 8, 2023



In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.
― Rudiger Dornbusch

Financial conditions have been squeezed by tighter monetary policy, plunging monetary aggregates, and a resurgent dollar. The dollar liquidity tanks are draining, and the resultant shortage reminds us that it might be their currency, but it is our problem.

Dollar debt and dollar-priced energy have become more expensive. Although most major BRICS nations are prepared, many weaker developing countries face economic hardship as energy-related current account deficits get out of control. The list of nations waiting for triage at the IMF and World Bank is growing.

Although partially protected by their ability to print their own currencies, the developed nations of Europe and Japan are forced closer, albeit more slowly, to the same financial cliff edge. Rising bond yields with looming maturity walls constrain government, business, and consumer spending plans. The abandonment of HS2 is not an isolated example. The US has so far been unscathed by exporting the negative consequences of running high levels of deficit-funded spending. However, the bond market vigilantes are now calling this into question.

Just as the Fed and BoE paused two years of non-stop rate hikes as inflation eased, the large fiscal deficits of the major developed economies have reared their ugly heads and bond markets have puked at the prospect of increased supply. The US Treasury must find buyers of more than $2tn Treasury bonds a year until the decade end to meet the requirements of the Chips Act and the Inflation Reduction Act and the cost of the military support of Ukraine. Draining the reverse repo tank will mop up a few more shorter-duration T-Bills, but households, pension funds, and insurance companies must buy the longer-duration bonds, and they need a higher return.

Financial markets are deep into “good news is bad news” territory. This week’s stronger-than-expected US manufacturing survey and upwardly revised job openings data have fuelled the well-rehearsed “necessary multiple further hikes” rhetoric of the FOMC and MPC. Investors would welcome the relief of sharply higher unemployment. The critical non-farm payrolls continue to show a strong jobs market. The truth is the Fed and the BoE want you to lose your job to achieve their objective. And until the central banks decide it is time to release the pressure valve, the bond vigilantes are back in Dodge and controlling the direction of financial markets. Debt everywhere, particularly the longer duration variety, is getting more expensive. As Bloomberg cheerily declared this week, “The 5% Bond Market Means Pain is Heading Everyone’s Way.”

Amidst this turmoil, the sharply inverted yield curves of the last eighteen months, the traditional indicators of impending recession, are flattening out. It is worth remembering that Jay Powell acknowledged in his Jackson Hole speech that current policy rates are above the theoretical R* equilibrium. So, despite the coordinated rhetoric of higher for longer and multiple further hikes, something will break unless the monetary release valve is opened. The rivets on our financial market machinery are starting to pop. As Star Trek’s Chief Engineer “Scotty” Scott would say, “I’m giving her all she’s got, Captain! She cannae take anymore.”

However, central bankers have dug themselves into a hole over inflation targeting. Two recent examples from the energy market illustrate how fragile some of our most vital supply chains have become. In July, Saudi Arabia announced plans to reduce oil production by a million barrels a day, about 1% of global consumption. The price spiked by over 30% in the following weeks.

Meanwhile, a military coup in Saharan Niger halted the supply of about 5% of the world’s annual Uranium production. The spot yellow cake price (the raw material that feeds the world’s nuclear reactors) rose 28% in the following 12 weeks. These are examples of how a fracturing global trading system can bring forth commodity volatility and structurally higher levels of inflation.

The changing trajectory of the world’s bond markets is saying that we have reached the point where demand management can no longer fix things, and supply-side reforms must be re-prioritised. This overlooked aspect of the UK’s policy debate since Liz Truss and Kwasi Kwarteng disappeared in a cloud of smoke a year ago is likely to feature more prominently as the UK heads into the next general election.

So, too, in the US, Joe Biden’s re-election could rest on the potential for a rapprochement with Saudi Arabia. To this end, Joe and MBS must replace their last cursory fist bump with a hug. Joe needs lower pump prices, and MBS wants weapons, security, and respect. However, this is no pushover for the State Department. China is now Aramco’s biggest customer and has a strong appeal among the Kingdom’s secret police with the CCP’s superior surveillance technology and a track record in social control.

In the UK, the sanctioning of the North Sea Rosebank development, the stepping back from certain restrictive green policies and proposals to deregulate our primary capital markets represent some early steps towards growing the economy. For now, though, the bond vigilantes are running the show and want to break things. Brace for a bumpy landing.


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