A holy junction has arrived. As I write, the world’s Christians are ready to commemorate Good Friday, the day when Jesus gave his life on the cross, while Jews prepare for Passover, the festival that commemorates their exodus from Egypt. It is an ideal moment for reflection.
1. Why are Treasury yields falling again, when only a matter of weeks ago they appeared to have conclusively moved into the long-dreaded secular bear market?
The argument for a secular bear market — with falling bond prices and hence rising yields — seems clear. The US economy is strong, and for several months there has been a synchronised global recovery. That should mean higher inflation in the long run, and higher bond yields to compensate for it. One huge extra force pushing down on bond yields, of course, has come from central banks. Low interest rates, plus deliberate actions to buy bonds and hence raise their price and reduce their yields, have sustained the bull market that started in the early 1980s.
Those actions are now being reversed in the US, as the new Fed governor made clear this month, while Uncle Sam is selling more new bonds to finance the US deficit, which is growing after the tax cut. Higher supply plus lower demand should mean a lower price and higher yields.
Finally, there is the issue of trend — bond yields had been locked in a steady downward trend, which was the most reliable in world markets. In the last week of January, just before volatility hit the equity market, that trend was broken when the yield surpassed 2.68 per cent. That was supposed to herald a swift rise to 3 per cent and beyond. So why has the 10-year yield instead dropped back to 2.74 per cent?
In part the “structural” factors that have been pushing down on yields remain strong. Insurers need to buy bonds for regulatory reasons; yields are far lower elsewhere so this creates demand to buy US bonds, thus depressing their yields; and demographic trends, with ageing populations, also tend to boost buying of bonds. We will now find out how strong those forces are.
In the short term there are two other factors. First, very many people were happy that yields were rising. It was a consensus trade, if not an overcrowded one, and they are now being punished. Second, and more important, macroeconomic data have looked less impressive of late, particularly in Europe, while inflation is failing to rise as many had expected. If the world is still not emerging into a stronger growth trend, then there is less need for yields to rise — and a lot of other calculations will go awry.
2. Why are stock markets so volatile when for years they had been as calm as they have ever been?
US stocks suffered their first negative quarter since 2015. This happened despite great earnings results, and continuing strong macroeconomic numbers, as the corporate tax cut agreed at the end of 2017 came into effect. In January, stocks went into a pronounced tear, egged on by celebratory tweets from the president of the US, and appeared to be melting up. By the end of the quarter, the main US indices were down, as were all the main world indices. What happened?
Initially, stocks sold off because of some worrying inflation data, which helped to push up bond yields (which in turn meant there was less support for equity valuations). But as we have just seen, the moves upwards in inflation and in bond yields are now called into question, and yet stocks are still down for the year.
The business models of the Faang stocks (Facebook, Apple, Amazon, Netflix, Google), which had led the market for more than a year, have been called into question. This has damaged sentiment. But again, the NYSE Fang+ index remains up for the year. If we are really going to reappraise the stocks that have been leading the market, there is much further to go.
Maybe, just maybe, it’s the Trump effect. The tax cut has been achieved. We are no longer so sure that his remaining ideas are so good, and most investors think his ideas about trade are downright terrible. And so the market has started reacting to presidential tweets. For more than a year, it had comfortably ignored them.
Most importantly, though, key assumptions have been stripped away. We can no longer rely on low volatility. And critically, the positive view of a low-inflation strong-growth future has been called into question — but only after the stock market had priced in that assumption as a done deal. Let us hope that that assumption does not turn out to be downright wrong.
3. Why is the dollar weakening when at all other times the high yields on Treasury bonds would pull money into the US?
Generally, money flows where it can make the highest interest rate. And yields on US bonds have recently exceeded those available on European bonds by 2.3 percentage points; five years ago, this figure was barely 0.5 percentage points. This should attract money to the US, and push up the dollar, and yet the opposite is happening, with the dollar dropping more than 2 per cent against a trade-weighted basket of currencies in the first quarter. Why?
There are a few simple explanations. First, the oil price is rising. Oil transactions are denominated in dollars, so as oil rises, sellers are left more with dollars (“petro-dollars”) that need to be sold; over history there is a clear inverse relationship between oil prices and the dollar. And more generally, economic growth and confidence tends to mean a weaker dollar, because this reduces demand for US assets as a “safe haven”.
But this does not quite work. Of late, bond and stock markets have shown a sharp attack of nerves about growth, and the dollar has stayed weak. Again, the easy answer many tend to offer comes from the political row of the moment: the US is threatening trade tariffs, the president has talked openly of winning a trade war, and this might be scaring potential investors away from the dollar. A trade war still looks unlikely — a return to 1930s-style tariffs walls is not in anyone’s interests. So this implies that more dollar strength could be in the offing, but it also suggests that markets really are nervous about trade tensión.
4. Why is inflation still so low everywhere when unemployment appears to have been beaten in the US, and is falling almost everywhere else?
The economic debate over the “Phillips Curve” has riven academic economics for decades and now it is dividing opinion in capital markets. Low unemployment should mean higher bargaining power for workers, hence higher wage inflation, and hence higher price inflation. In the US in the last week before Easter, fewer people signed on as jobless than in any week since 1969, while unemployment rates have dived across the rest of the world. And yet inflation is supine: the PCE deflator, the Fed’s preferred measure, came in at 1.8 per cent, safely below the 2 per cent target.
One explanation is that there is an overhang of workers who do not appear in the unemployment figures because they are not making themselves available for work. If this is voluntary, then as prospects improve, they will steadily return to work and wages will not inflate as expected. If it turns out that the people not making themselves available for work are, in fact, unemployable, as they lack the skills for the modern economy, then wage inflation is more plausible.
Another explanation is that the relationship between unemployment and inflation is not all that strong. That would imply that the long era of low rates, low inflation and unimpressive growth can continue. And as so many have been allocating their money on the assumption that that era is over, it could lead to some very difficult times on markets.
Economics is, like medicine (and unlike, say, cosmology), a practical discipline. Its goal is to make the world a better place. This is particularly true of macroeconomics, which was invented by John Maynard Keynes in response to the Great Depression. The tests of this discipline are whether its adepts understand what might go wrong in the economy and how to put it right.
When the financial crisis that hit in 2007 caught the profession almost completely unawares, it failed the first of these tests. It did better on the second. Nevertheless, it needs rebuilding.
In a blog for the Financial Times in 2009, Willem Buiter, now at Citi, argued that: “Most mainstream macroeconomic theoretical innovations since the 1970s . . . have turned out to be self-referential, inward-looking distractions at best.” An exceptionally thorough analysis, published in the Oxford Review of Economic Policy, under the title “Rebuilding Macroeconomic Theory”, leads this reader to much the same position. The canonical approach did indeed prove gravely defective. Moreover, top class professional economists differ profoundly on what to do about it. Socrates might say that awareness of one’s ignorance is far better than the illusion of knowledge. If so, macroeconomics is in good shape.
As David Vines and Samuel Wills explain in their excellent overview, the core macroeconomic model rested on two critical assumptions: the efficient markets hypothesis and rational expectations. Neither looks convincing today. It is questionable whether it is even possible to have “rational expectations” of a profoundly uncertain future. Such uncertainty helps explain the existence of institutions — money, debt and banks — whose effects are so significant and yet were largely ignored in standard models. It is better to be roughly right than precisely wrong. Thus, Hyman Minsky’s view of the dangers of speculative tendencies in finance was roughly right, while many of the brightest macroeconomists proved precisely wrong.
It is not good enough to argue that the canonical model works in normal times. We need also to understand the risks of crises and what to do about them. This is partly because crises are, as the Nobel-laureate Joseph Stiglitz notes, the most costly events. A macroeconomics that does not include the possibility of crises misses the essential, just as would a medicine that assumes away the possibility of heart attacks. Moreover, crises are endogenous: that is to say, they come from within the economy. They are a result of the interaction between tendencies towards excessive optimism and the fragility of any system of highly leveraged financial intermediaries.
My colleague Martin Sandbu notes, in particular, the possibility of “multiple equilibria” — the idea that economies might end up in self-reinforcing bad states of the world. This possibility makes it vital to respond to crises forcefully. Doctors’ first response to a heart attack is, after all, not to tell the patient to go on a diet. That happens only after they have dealt with the attack itself.
So a big question is not only whether we know how to respond to a crisis, but whether we did so. In his contribution, the Nobel laureate Paul Krugman argues, to my mind persuasively, that the basic Keynesian remedies — a strong fiscal and monetary response — remain right. Also vital is swift revitalisation of the banking system. The contrast between the swifter US recovery and the dreadful delays in the eurozone gives striking support for this view. Essentially, the latter lost five years before the recovery began.
A comparison between what happened in the 1930s and this post-crash period shows we have indeed learnt some important things. Compared with the Great Depression, the immediate declines in output and rises in unemployment were far smaller. Moreover, prices have also been far more stable this time. These are true successes. Nevertheless, after a decade, the level of output per head, relative to pre-crisis levels, is less impressive: Germany and the UK did even better last time. Moreover, the worst hit eurozone countries have suffered badly, by any standards. This recovery really has not been a triumph.
This suggests that fixing a huge crisis after the event is terribly hard. The obvious need then is to make economies more resilient. Even if we do not fully understand the economic dynamics, the broad lessons for the reform of our economies seem clear. Economies would be more resilient if they were less highly leveraged and, in particular, if they depended less on holdings of money backed by risky assets owned by the highly leveraged financial intermediaries known as banks. Obvious solutions include eliminating the incentives towards leverage in our tax systems, encouraging greater use by the economy of equity finance and debt that can be readily converted into equity, raising the reserve and capital requirements of banks and moving swiftly towards the issuance of digital central bank cash.
The analysis of fundamental macroeconomic theory suggests substantial ignorance of how our economies work. This is not that surprising. We may never understand how such complex systems — animated, as they are, by human desires and misunderstandings — actually function. This does not mean that attempting to improve understanding is a foolish exercise. On the contrary, it is important. But it is arguably more vital in practice to focus on two other tasks. The first is how to make the body economic more resistant to the consequences of manias and panics. The second is how to restore it to health as quickly as possible. On both counts, we need to think more and do more. These are the practical challenges before us.
The world has felt more normal in recent months, in economic terms at least, with global growth robust and inflation, not deflation, the worry. But things are still far from settled. The widening gap in a key bond trade is one piece of evidence, which also highlights the puzzle of the weaker dollar.
At 2.28 percentage points, the spread between U.S. and German bond 10-year yields is close to the 2.32-point peak of 2016, itself a level not seen since before the Berlin Wall fell in 1989. Before the global financial crisis, the spread was narrower as the U.S. and European economies—and hence monetary policy—tended to move more in tandem. This has been replaced by a vast gulf.
Lately, Treasury yields have opened the gap again; German yields look puzzlingly low for a world where the outlook is brighter.
One explanation may be that the U.S. economic cycle is more advanced, meaning inflation is more of a concern than in Europe. It also means some are concerned the U.S. might tip into recession sooner rather than later: A U.S. slowdown will hurt everywhere. Global bond yields, like the bund, should remain low if growth is a concern.
Sources: Congressional Budget Office; EurostatNote: negative numbers indicate a deficit, positive a surplus. Data for U.S. to 2017, for eurozoneto 2016.
Another factor is that the European Central Bank is still in the earliest stages of removing stimulus, having yet to stop bond purchases. Its deposit rate is still negative and a first increase is only expected in 2019. ECB policy ensures short-term yields don’t move too much, which limits the ability of long-end rates to rise. That, plus a steeper yield curve, may make bunds relatively attractive for conservative investors, since the ECB is reducing volatility.
The renewed widening in the rate differential across the Atlantic also raises anew the question about why the dollar has weakened against the euro. A factor worth considering lies in fiscal rather than monetary policy. A higher U.S. budget deficit needs an offset: both higher yields and a weaker dollar are part of that. The eurozone, meanwhile, isn’t about to go on a budget splurge.
What are investors to do? In the longer term there is clearly room for German yields to rise given their low level. But for now, the focus is on the U.S. where rates are moving faster. The gap could get wider still.
Is the Press Too Free?
LONDON – The poisoning of Russian double agent Sergei Skripal and his daughter Yulia at an Italian restaurant in Salisbury has driven an important story off the front pages of the British press. Earlier this month, the former actor and comedian John Ford revealed that for 15 years, from 1995 to 2010, he was employed by Rupert Murdoch’s Sunday Times newspaper to hack and blag his way into the private affairs of dozens of prominent people, including then-Prime Minister Gordon Brown.
Discussing the techniques he used, Ford said: “I did their phones, I did their mobiles, I did their bank accounts, I stole their rubbish.” Some of the most prominent names in British journalism are likely to be tarnished by this and other revelations of illegality and wrongdoing.
The basic plot goes back to the foundation of the free press with the abolition of licensing in 1695. To fulfill what has been seen since then as its distinctive purpose – holding power to account – a free press needs information. We expect a free press to investigate the exercise of power and bring abuses to light. In this context, one inevitably recalls the exposure of Watergate, which brought down President Richard Nixon in 1974.
But actual scandals are not necessary for the press to do its job. The very existence of a free press is a constraint on government. It is not the only one: the rule of law, enforced by an independent judiciary, and competitive elections held at regular intervals are no less important.
Together, they form a three-legged stool: take one, and the other two collapse.
We continue to view the press as our defender against an over-mighty state, despite politicians’ often-craven performance in the face of media pressure. This is because we have no proper theory of private power.
The liberal argument is both simple and simplistic: the state is dangerous precisely because it is a monopolist. Because it controls the means of coercion and levies compulsory taxes, its dark doings need to be exposed by fearless investigative journalism. Newspapers, by contrast, are not monopolists. They lack any power of compulsion, so there is no need to guard against the abuse of press power. It does not exist.
But while a press monopoly in its pure form does not exist, oligopoly prevails in most countries. If, as economists claim, the public good emerges from the invisible hand of the market, the market for news is quite visible – and visibly concentrated. Eight companies own Britain’s 12 national newspapers, and four proprietors account for more than 80% of all copies sold. In 2013, two men, Murdoch and Lord Rothermere, owned 52% of online and print news publications in the United Kingdom. Were it not for the success of the press in rendering its own power invisible, we would never rely on self-regulation alone to keep the press honest.
Efforts to bind the British press to a standard of “decent” journalism have been tried – and failed – repeatedly. There have been six commissions of inquiry in the UK since 1945. Each one, established after some egregious abuse, has recommended that “steps be taken” to protect privacy; and each time, the government has backed down.
There are two main reasons for this. First, no politician wants to turn the press against him: Tony Blair’s wooing of Murdoch, owner the Sun, the Times, and the Sunday Times, is legendary, as was its pay-off. The Murdoch press backed Labour in Blair’s three election victories in 1997, 2001, and 2005. The other reason is more sinister: newspapers have “dirt” on politicians, which they are willing to use to protect their interests.
In 1989, following pressure from Parliament, the government commissioned David Calcutt to chair a committee to “consider what measures (whether legislative or otherwise) are needed to give further protection to individual privacy from the activities of the press and improve recourse against the press for the individual citizen.” Calcutt’s key recommendation was to replace the moribund Press Council with a Press Complaints Commission (PCC), which was duly created.
In 1993, however, Calcutt described the PCC as “a body set up by the industry, financed by the industry, dominated by the industry, and operating a code of practice devised by the industry and which is over-favorable to the industry.” He recommended its replacement by a statutory Press Complaints Tribunal. The government refused to act.
In March 2011, a Joint Committee of Parliament reported that “the current system of self-regulation is broken and needs fixing.” Because the PCC “was not equipped to deal with systemic and illegal invasions of privacy,” the committee set out proposals for a reformed regulator.
The first part of the Leveson Report, published in 2012, recommended an industry regulator whose independence from the newspapers and government alike was to be assured by a Press Recognition Panel, set up under a Royal Charter. To preempt what they called “state control,” the newspaper proprietors set up an Independent Press Standards Organization (IPSO), accountable to no one but itself.
True to previous form, the government then gave up, overruling the opinion of Leveson himself that further inquiry was needed to establish the “extent of unlawful or improper conduct by newspapers, including corrupt payments to the police.” Indeed, Leveson doubted whether the IPSO is sufficiently different from its predecessor, the PCC, to have resulted in any “real difference in behavior” at all.
Although some British press outlets are uniquely vicious, striking the right balance between the public’s need to know and individuals’ right to privacy is a general problem, and must be continually addressed in the light of changing technology and practices. The media are still needed to protect us against abuses of state power; but we need the state to protect us from abuses of media power.
1. It could kick back and let China displace it as the most powerful country in the world.
2. It could start a military war with China.
3. And it could push the current trade battle into an all-out economic war against China.
For decades, the US has been able to exclude virtually any country it wants from international trade.
Right now, if one country wants to trade with another, it basically needs US permission first.
Most investors know that oil is the largest and most strategic commodity market in the world.