Below, we look at the relationship between central banks, bond markets, rising yields, rising rates, and the added insult of a trade war.
Europe on the Mind?
There’s a lot to think about these days.
Stocks and bonds (especially), of course, are on my mind, and as I head toward the Mediterranean next week, I’ll get to talk to a few Italians about their own woes, of which I’ve already written about at some length.
To wit, the Eurozone, like the US, is looking down the barrel of increasing yields and thus interest rates, which will be a real kill-joy for their credit markets. In short, the ECB’s central bank party is tilting toward its own mathematically inevitable hangover phase…
And as Italy triggers the first sparks of a credit fire in the EU, we here in the US are facing a 2019 that promises over $1.8T of simultaneous US Treasury selling and US Fed tightening—i.e. yield/rate landmines are planted throughout our bond pits—and thus throughout our dangerously over-valued “market recovery.”
And as we’ll see below, it’s not just US bond selling (and market-killing interest rates) we have to worry about, but foreign bond selling as well.
Which means the threat of rising rates (the enemy of all debt-driven market bubbles) will be coming at us from all sides in the near and distant future.
And as we will also see below, rising rates, which means a rising dollar, is just about the last thing America needs for its export markets and trade deficits. In fact, the only thing that could make that situation worse is a trade war…
Politics and French Wine
A big part of my family life involves France, and whether I like it or not, the French love to talk politics, and so I’m already bracing myself for every possible Trump debate I can imagine among every possible wine I intend to consume to dull the pain.
As I’ve written elsewhere, I’m well past thinking blue or red (or even rose), and regardless of your or my views of this highly controversial President, I like to stick to math more than politics, largely because math has more room for certainty and less room for ranting.
That being said, politics and math are beginning to overlap, specifically with regard to the headline making trade war and refreshingly American tough-talk coming out of the White House in the foreground of a $21T per year global trade environment.
In short, and like it or not, we need to toe-dip here into some Trump talk…
Perfect Storm: Rates, Currencies, and Tariffs
In particular, we need to consider the relationship between trade wars, bond markets, central banks, currencies, and yield shocks—all of which are converging to form a nearly perfect storm ahead for US and global markets.
As I’ve written elsewhere, it’s easy, at first blush, to understand Trump’s rancor at the undeniable ($800B) trade deficit that the US has endured in general and against China in particular.
As the ghost-written protagonist of the “Art of the Deal,” Trump sincerely believes that US trade deficits are directly linked to prior and bad US trade deals—namely NAFTA and various old WTO trade rounds, all of which he ascribes to past (and “stupid”) administrations in Washington.
For most Americans, such tough talk seems reasonable. It makes us feel like we are fighting back from being taken advantage of by the rest of the world.
Trade Victim or Villain?
But let’s look at the numbers.
First, the majority of the world’s tariffs leading up to this trade war averaged less than 4%–so it’s not as if international tariffs, alone, amounted to a real crisis for our national security or the American-victim meme.
In fact, the US has been the sole beneficiary of extremely generous NTB’s (“Non-Tariff Barriers) by which every country has preferences to “Buy American” via government procurement and health and safety regulations which are massively biased in our favor and against foreign suppliers.
Of course, there are/were some extreme outliers, such as Canada’s 250+% tariff on dairy products or the US’s own 25% tariff on trucks.
But for the most part, past global trade costs weren’t that extreme. As such, Trump’s blitzkrieg of nationalistic protectionism is more political rhetoric than economic reality.
More importantly, the tough-talk is causing (and already has caused) an equally nationalistic backlash from the rest of the world, whose politicians see no other option than tit-for-tat tariff increases on US goods which will in fact hurt, rather than help, our already weak trade balances and export figures.
But here’s a logical question:
How did the US end up with an $800B trade deficit and 40+ years in a row of current account deficits (racking up to almost $20T in inflation-adjusted dollars) in the first place?
In short, how did we end up in such a pickle?
Was it just bad trade deals, easily reversible with Trump’s tougher and better trade deals? Are we really the victims of unfair trade deals overseas?
The quick answer, at least from my desk, is sadly a resounding: No.
I touched more on this point in my April blog, which you may want to re-visit here.
And to better address this question (i.e. go deeper), I have no choice but to fall back on the ultimate villain in the room who just about nobody in the MSM understands or wants to discuss.
Not surprisingly: It’s the Fed—the monster I never stop wanting to discuss…
Huh? The Fed? How so?
As I’ve written till just about red in the face and blue on the tips of my fingers, the Fed’s “brilliant” decision years ago to print trillions of dollars out of thin air to “save America” was about the boldest example of “bluffing it” in the history of capital markets.
Yet amazingly—and at least for now, during the good-times—hardly anyone seems to know this.
But many of you, by now, recognize that the Fed basically engineered a Wall Street bubble, not a Main Street rescue…
That is, as Wall Street’s publically-traded companies focused on share-prices, they turned their post-08 attention away from such old-fashioned things like US-based labor, CapEx, and manufacturing and focused clever accounting and share-price inflation.
Once the Fed began its post-08/QE money printing and interest-rate cramming, American companies largely stopped investing in their operations and focused instead on speculating in markets, buying back their own stocks, and creating a securities hockey-stick rise rather than a manufacturing or service-focused recovery.
Such miss-focus, of course, negatively impacted our exports…
The Other Central Banks
Meanwhile, the equally brilliant central banks of the rest of the world followed suit as their own respective markets suffered in the wake of our 08 debacle, collectively expanding their balance sheets with printed fiat currencies from $4T in 1998 to a combined $24T today.
But in order for those foreign banks to keep up with our punch-drunk academics at the Fed, they had no choice but to buy dollars and sell their own currencies in order to control (i.e. cap) their FX (currency exchange) rates and thereby protect their own economies from seeing their domestic currencies grow too strong against an increasingly diluted USD.
In short, in a world awash in fiat currencies, the Fed money-printers and debt-lovers began an international “race to the bottom” in a global currency war of “bugger-thy-neighbor.”
In this process, lots of foreign flags, from the Emerging Markets to of course China, were buying our Treasury bonds and GSE paper by the truckload just to manage their own currency pegs—and hence their exports.
Parties and Hangovers
Fast forward to today, and the major central banks of the world, including the dimwits at the Fed, are realizing they can’t party forever on debt, printed money and artificial rate fixing. In short, we are seeing a global-pivot from bond buying to bond dumping in the world of central banking.
As to that “dumping”—this means countries around the world who were buying our bonds are going to be forced to sell those bonds.
Why? Because they too need more money (and dry powder) to brace themselves (and their respective economies) for the big QE to QT pivot (and recession/hangover) to come.
Of course, as the rest of the world (viz. China, Japan and the EM satellites) start dumping US bonds (at least $3T of which they currently hold) alongside the Fed’s forecasted $600B sell-off at year-end (Russia, btw, just sold $50B worth), guess what that means for US yields and rates?
Up, up and away…
Rising Interest Rates, Dollars and Trade Wars
So, what does all this have to do with trade deficits and wars?
Well for one, rising rates means the dollar’s strength is going to rise alongside the rising yields on the US 10 year. And guess what—a strong dollar is very, very, very bad for US exports.
As the dollar’s strength rises, everything from US toasters to SUV’s becomes too expensive for overseas buyers. When you tack on retaliatory tariffs from our increasingly angry trade “partners” overseas to that equation, US manufacturers are gonna see massively dwindling sales/profits and hence share prices.
Sadly, it seems that neither Trump nor his entourage of tweeters and media-message-managers understands the deeply nuanced yet inter-connected forces of bond markets, currency moves and trade agreements.
Sometimes it helps to have leaders who know markets rather than messaging.
In short folks, the combinations of rising tariffs and rising yields is NOT gonna make America great.
A strong dollar + retaliatory foreign tariff penalties = a kick in the gut (rather than victory cry) to American manufacturing, American exports and hence American trade deficits.
But for now, at least the headlines are making us look tough. Sadly, there’s more to being great than tough-talk.
Math matters too…