My 4 May post was titled “‘Sell in May and go away?’ as US, German bond yields jump“. Since then, US interest rates have continued to soar and the US stock market is starting to wobble, as I discussed last week. Now emerging markets are in the line of fire. $9.3bn was withdrawn last week – the highest figure since the financial crisis began.
But developments in German markets have been most extraordinary, as the above charts from ThomsonReuters show. Germany is the world’s 4th largest economy, and had been seen as a beacon of stability in an uncertain world:
- Just 2 months ago, on 10 April, its DAX Index of leading shares hit an all-time high of 12374 (top chart)
- On 17 April, the German 10 Year bond yield hit an all-time low of just 0.049% (bottom chart)
- Last Friday, the DAX closed down 10% versus its high at 11196
- And the yield on the 10 year bond was 17x higher than its low, at 0.85%
Even more worrying is that the consensus view of major analysts completely failed to forecast these developments. Instead, they all believed that German interest rates would continue to fall and its stock market would rise. Thus on 16 April, Bloomberg quoted one leading interest rate analyst as forecasting:
“There’s room for them to fall further given the ECB’s policy. There are willing buyers and not many willing sellers because they can make capital gains if yields keep falling.”
Whilst on 10 April, the Financial Times reported that “the Xetra Dax in Frankfurt and London’s FTSE 100 both ended at record peaks.”
The problem is that most analysts have only ever known a world where central banks kept pumping markets higher, and interest rates lower, via their liquidity programmes. These began as long ago as Q4 1999 with the Y2K liquidity injection, and then continued through the subprime mania to the post-2008 QE programmes.
The result is that very few people in the markets remember a period when the fundamentals of supply/demand set prices, and markets themselves were a vehicle for price discovery. This is why I fear we will see massive volatility as Stage 2 of the Great Unwinding of policymaker stimulus gets underway.
The debt mountains around the world are each frightening enough in themselves. But together they represent a ‘Ring of Fire‘. Greece is moving closer to crisis, and Reuters last week confirmed my argument that European governments fear major domestic upset if Greece defaults on its debt, and thereby destroys their ‘pretend and extend’ policy:
“IMF chief Christine Lagarde is hinting that European governments need to give Greece debt relief to make the numbers add up, but since this is politically unacceptable in Germany, she has had to talk in code in public…Behind closed doors, IMF officials are telling the Europeans that Greece will not survive without a third bailout program, which will require debt restructuring by European governments.”
And if it is not Greece, then it could easily be house prices in markets such as China, Singapore, London or New York. These are all held aloft, as the saying goes, “on a wing and a prayer”: they long ago lost contact with the borrower’s ability to repay out of their income. And if not house prices, then energy markets, where vast investment ($1.2tn in the US alone) has created major surpluses, at a time when demand growth is slowing sharply.
The issue is that the market’s obsession with US interest rate policy has blinded it to the reality of today’s New Normal world. We urgently need our political leaders to begin sensible conversations with the voters about the hard choices that need to be made. They cannot continue to hide behind the figleaf of monetary policy forever.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 41%. “The recent spate of cracker outages seen in Europe was also potentially having a tightening effect on benzene availability.”
Brent crude oil, down 39%
Naphtha Europe, down 36%. “Strong gasoline demand in the US and Asia continues, with the July naphtha crack spread staying strong in line with the exceptionally high gasoline refining margins.”
PTA China, down 29%. “export orders for their products were also slow, resulting in strong resistance for feedstock prices..”
HDPE US export, down 17%. “Domestic export prices held steady”
¥:$, down 21%
S&P 500 stock market index, up 7%