Monday digest

Posted 21 November 2022

Overview: Prospects of a Fed pivot put on pause
On the whole, investors enjoyed another positive week in markets, as better-than-expected US retail spending figures, a falling dollar and still-declining European energy prices prolonged last week’s positive sentiment swing initiated by slowing US inflation. The downside of this is that all these data points indicate more current and future resilience in the US economy and a potentially shallower recession in Europe. This is all unlikely to provide central banks with the confidence that labour supply pressures are likely to ease any time soon and with that second-round inflation pressures. As a result, a near-term pivot in their monetary policy away from tightening is no more likely now than it was a month ago. The December meeting of the US Federal Reserve rate setters will be awaited with a fair dose of nervousness, and anything less than a clear signal of a pivot is likely to lead to significant market disappointment.

Return of ‘Rishinomics’ plugs the holes
Last week’s Autumn Statement was perceived as quite sensible from a capital market perspective, with sterling and bond yields closing within their most recent trading ranges. However, it is hard to shake the feeling that the measures introduced amounted to little more than a short-term repair job rather than a long-term strategy to overcome the UK’s structural weaknesses: comparatively low productivity – caused by the lack of capital and education investment – paired with a paucity of post-Brexit trade opportunities.

So, Trussonomics is history, while Rishinomics returns. For now it seems Chancellor Jeremy Hunt has managed to keep foreign buyers of UK government bonds onside, while maintaining the enormous fiscal expansion of the energy price cap but pushing the bulk of the tax rises and spending cuts into the next parliament in 2024 and beyond. No wonder the shadow Chancellor called the postponement of the brunt of the tax rises and public spending cuts an election ‘trap’. Should dire Office for Budget Responsibility (OBR) forecasts become reality, UK households will be faced with the inevitability of shrinking real incomes for years to come. But the OBR report also contained a few lifelines for UK wage-earners, such as the prospect that inflation may well turn negative in 2024 and pull down mortgage costs with it. Given the recent steep fall in European gas and electricity prices, the energy cost price shock may also end sooner, lowering the upward pressure on energy-intensive goods.

China bullishness returns
While the UK public was focused on the Autumn Statement, and despaired over the latest inflation data, the most significant news in the global investment world once again came from China. Less than a month ago, overseas investors were fleeing, and commentators were decrying China was yet again becoming “un-investable”, following the dogmatic inflexibility on display at the Communist Party congress a few weeks ago. This resulted in a 20% stock market drop over October. Now, those losses are more or less recovered, thanks to an impressive two-and-a-half-week Chinese stock market rally.

Like the losses beforehand, recent gains have been driven by political decisions. In the last couple of weeks, Beijing has changed its tune on three extremely important issues. Firstly, policymakers issued a sweeping plan to help the struggling property sector. Secondly, official Covid rules were relaxed, in the first major sign that President Xi might change his zero-Covid directives. And finally, Xi’s appearance at the G20 summit, where he held a one-on-one meeting with US President Biden, pointed to better relations between China and its major trading partners. We should not get ahead of ourselves: the biggest problems in US-China relations are deep-rooted, ranging from economic ideology to Taiwan’s independence. These will not go away with a few nice words. Even if Xi is happy to shelve his plans for annexing Taiwan, it is a goal tied up in the very fabric of the People’s Republic. Geopolitical flashpoints are therefore a given in the months and years ahead.

Even so, the pragmatism shown by Beijing in the past couple of weeks is comforting. To be sure, Xi’s extreme consolidation of power of the last decade has shifted China’s focus from growth and globalisation to stability and ideological conformity. But as we have often noted, a vibrant private sector is crucial to China’s future, and the government has repeatedly made attempts to support that. China has been one of the biggest contributors to global growth for more than a decade and, being at a completely different stage of its cycle, a policy push now could counteract weakness elsewhere. What’s more, because of China’s production build-up over the pandemic, the growth it pushes out to the world might not even be inflationary. This is an optimistic scenario, but a perfectly plausible one. As ever with China, investors must keep an eye on the risks – but the short-term benefits could be vast.

FTX: A pitfall on the path to ‘cryptomaturity’?
The dust is still settling from the collapse of FTX, the cryptocurrency trading hub that went into meltdown earlier this month. For the uninitiated, FTX is a digital currency exchange run by (former) crypto icon Sam Bankman-Fried. Bankman-Fried was regarded by industry insiders and regulators alike as the Warren Buffet of the crypto world, though the last few weeks have made him look more like its Bernie Madoff. Michael Lewis, author of Liars’ Poker and The Big Short was in the process of writing a book about him when the troubles emerged – given he writes about financial disasters, Lewis remains remarkably prescient.

For all the technicalities and jargon surrounding this story, the basic plotline is all too familiar: certain market players tried to hide their leverage to make assets look better than they really were. It went so well they felt like they could print their own money. In FTX’s case, this was literally true: the value of its own FTT token was backed by more FTT. When this came to light, the whole thing unravelled spectacularly. Commentators have suggested this could be the crypto market’s ‘Lehman moment’, as other exchanges struggle to mitigate their exposure and shore up liquidity. Any rush of that sort inevitably means forced selling, and the majority of cryptocurrency exchanges’ assets are cryptocurrencies. We should therefore expect to see price falls across the crypto space. Sure enough, Bitcoin – the most well-known cryptocurrency, has fallen about 20% since the start of November.

FTX is not Lehman’s, by a long stretch. But its demise is certainly a destruction of capital, and it may be a long time before we know the wider damage. While other crypto exchanges are the obvious ones in peril, we should not be surprised if other financial institutions take a hit down the line. It is notable, for example, that Bitcoin volatility has been relatively low, compared to previous crypto downturns. While this might show resilience in the crypto sphere, it might also point to a lack of appreciation for the deeper risks. Regardless, episodes like this are thinning the crypto field. The fallout is likely to increase volatility further even for the better-known brands, but it will hurt the little guys more. And in order to rebuild the trust of their believers those better-known brands might just have to accept regulation from the very institutions they demonised as inherently untrustworthy.

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