No one knows if we are facing into another recession but but if you haven’t looked at the positioning of your own financial products, now is probably a good time to do so, suggests economist Eddie Hobbs.
Investors in sovereign credit are worried that a recession is looming over the horizon. This is why the bond market throughout the world is flashing red, long term rates fell below short term, inverting the normal upward slope of the bond curve.
The most damaging doctrine carried forward from the 20th century may yet prove to be that of British economist John Maynard Keynes. That is how I ended The Pivot, a book I wrote for Jack & Jill in October 2017.
Why it matters is because everything from the value of your property to the stability of your cash deposits rests on Keynes being right. Central Banks and Governments throughout the world are betting on it too.
Dusting down Keynes ten years ago in the teeth of the GFC (Global Financial Crisis), Central Banks crushed interest rates, flooded banks with cheap money and bought securities at prices no one else would with trillions they magicked up. The plan was that this would be temporary, that Governments would structurally reform countries in the window created. They didn’t.
Central Banks short term fix has become open-ended. Risk asset prices, property, shares, corporate credit, private equity, it is all propped up and extended by so-called quantitative easing and money printing operations. Ten years after it kicked off, the danger zone has moved from housing debt to national debt.
You can prime a business or an economy with good debt, that is certain but when it becomes excessive it retards growth. You cannot print sustainable growth and when you interfere with the positive destruction and replacement cycle, which is the hidden hand of capitalism, instead you create monsters.
These are zombies, companies and national economies that exist purely on the basis of cheap open-ended money. Central Banks and their political masters have us in a trap, interest rates cannot be cut again to the same scale, the scope simply isn’t there.
Neither can rates rise without choking large parts of economies addicted to cheap money, that is clear. In the USA the Federal Reserve ran off the pitch, ditching its rate rises this year.
Trump, who has linked his Presidency to the barometer of the US stock market and the wealth effect of rising portfolio values, won’t like to read Morgan Stanley’s rolling warnings. It detects a notable slowdown in US services and manufacturing activity, prompting a cut to forecasts for this quarter from 1% to 0.6%.
Think of the economies as sponges that can take on too much water, too much debt leading to sluggish performance, little sign of wage growth for workers and a declining impact from stimulus. Debt has grown faster than economies, by half again since the GFC.
Central Banks, terrified of deflation are now looking at plumbing the depths of untested alchemy, negative interest rates where you pay to hold money in banks and helicopter money given directly to you to spend rather than to banks as cheap debt.
It hasn’t helped that Trump is adopting Economic Nationalism, unseen since before Bretton Woods in 1944, which follows the doctrine that to create economic growth at home you must first coerce it from abroad.
The interconnectivity of the modern global economy, which makes Trade Wars a self-inflicted wound, hasn’t stopped Trump who has threatened South Korea, Australia, Europe and Mexico, he is in a trade war with China and he has pulled the USA out of climate action.
Why this matters to us in Europe, is because unlike the USA, we have much lower growth and a base rate already on the floor which means we are more vulnerable to shocks at a time of elevated national debt.
The Eurozone banking system continues to carry a heavy burden of non-performing loans and is struggling to improve margins. The centrepiece of concern is Deutsche Bank whose share price continues to fall; it peaked May 2007 at €122 and hit a low over €17 after Lehmann Bros collapse and is now hovering at all time lows close to €6 per share.
Deutsche Bank a GSIB (Globally Systemically Important Bank) matters because of its transmission channels throughout the global financial system and its colossal derivative book estimated at net $40 trillion.
These are financial instruments that can go notoriously illiquid at times of crisis which is why the IMF describes Deutsche Bank as the world’s most dangerous bank pointing out that it makes the highest net contribution to global systemic risk. Behind each Bank connected to Deutsche Bank is a further web to medium sized and smaller banks, to the wiring of the global financial system itself.
What is less well known is the FSB (Financial Stability Board) established by the G20 in 2009 and first chaired by Mario Draghi.
Its work in 2011, Key Attributes of Effective Resolution Regimes for Financial Institutions, better known as the Bail-In report, was adopted by the EU Commission six years ago this month.
This allows for deposits to be decapitated when banks become insolvent, a resolution imposed on Cypriots in 2012. Bank default risk still matters and explains why Irelands largest deposit over €14bn is held by BNY Mellon in the USA. It is why all of us need to look closely at deposit risks.
So, is a recession really coming?
As ever no one knows until the next few quarters are revealed. US Fed rate cuts may buy more time, but one thing is clear, on this trajectory extreme monetary policies could lead to Japanese type conditions, long term tepid growth, very high national debt and at continued risk to deflation.
But until time unfolds, no one can tell if the next recession will be a cyclical one, short and shallow or a structural one, deep and long but if you haven’t looked at the positioning of your own financial products, now is probably a good time to do so.