It’s not just salads going off during these unprecedented times
We are fairly certain that when writing The Walrus and the Carpenter, Lewis Carrol never imagined a time that we would talk about “lettuces and queens”. However, such is the strangeness of the post-Covid era that the headlines over the last quarter have been dominated by stories about the UK’s longest-reigning monarch and shortest-serving prime minister, both of whom, of course, shared the same first name. That they found the time to meet is another twist of fate, and perhaps a playwright will be tempted to frame a narrative around a dialogue between the striking contrast of permanence and ephemerality that these two women now represent.
There is a broader point here about the changing nature of the relationship between government and its population. One of the predictions that we made at the height of the pandemic was that the massive fiscal support and heavy regulation of the public would legitimate a significant expansion of the role of government in our day-to-day lives. This has been the pattern of the past 30 months, but we are seeing increasing evidence in financial markets that the credibility of government is starting to ebb away. Although the debacle of the Truss administration may be the most acute example of this phenomenon, it is hardly alone. Furthermore, the wrong lesson is at risk of being learned from the short-lived attempt to cut tax rates. This was not a rejection of laissez-faire economics by markets, but of inept leadership and fiscal abandonment.
“Even before Covid there was a shift taking place within public finance”
Following the almost universal adoption of QE policies in the wake of the financial and euro crises, there was always a risk that the necessary expansion of a central bank balance sheet would lead to more reckless fiscal policies. To be fair, it took a while for this to play out (helped in the US by political gridlock being imposed in the 2010 midterm elections and Germany’s grip over Europe following the eurocrisis), but even before Covid there was a shift taking place within public finance. Consider the Trump administration’s aggressive tax cuts that were enacted in 2018, without much in the way of spending offsets. This was no reprise of Reaganomics, but instead a populist reform that promised a better life for some without being at the expense of others. Of course, this paled into insignificance once the pandemic struck, with all notion of fiscal probity understandably removed in the face of economic collapse in May 2020, and then two far more questionable massive fiscal handouts in late 2020 and early 2021.
“Equity and credit markets are both suffering their worst years since 2008
Until 2022, this appeared to be a well-received shift of economic principles, but the belated realisation that the inflation that came with it was not going to simply fade away has uncovered the costs of redistributing wealth from investors to recipients. Thus far in the US, the process has been orderly. Equity and credit markets are both suffering their worst years since 2008 and Treasury markets have given up roughly five years of gains, but thus far we have been trimming fat rather than muscle. Elsewhere things have been rather more frantic, with a number of key FX crosses breaking to multi-decade lows and the UK gilt market requiring a hasty intervention by the BOE.
China offers an alternate version of increased central control. The Xi administration had also been moving towards a much more heavy-handed administration of both the economy and general society before the pandemic, but there has been a massive acceleration of this process since the start of 2020. The early success that China had in limiting the impact of the pandemic on its population greatly increased the internal and external reputation of competence, while October’s politburo anointment of President Xi and his acolytes has cemented his grip on power. Of course, the Covid-zero obsession now looks to have trapped China’s population in a never-ending stop-go cycle of lockdowns and re-openings, and we can only imagine the psychological toll this must be taking. With political protest impossible, financial markets are really the only outlet for assessing any negative reaction and again we do see clear signs of a rejection.
The onshore A index recently tested its Covid panic low, while the Hong Kong listed H shares fell back to test their 2008 low. The Chinese yuan has traded above 7.30 to the USD for the first time since 2008, confounding the Xi administration’s aim of establishing it as a reliable store of value for commodity producers. In Hong Kong, the currency peg remains in effect, but roughly 20% of its FX reserves had been expended through September, even before the panicked flight of capital that followed Xi re-election. Regular readers may recall that we have flagged the potential for the re-pegging of the HKD against the CNY as a potential outlier event. We would still rate this move as ‘unlikely’, but it is no longer ‘unthinkable’.
Tensions between markets, governments and central banks seem likely to continue to build in the months ahead. Once again this has a very 1970s feel to it. Governments remain under pressure to deliver prosperity to their population and to protect them from the ravages of inflation. Central banks are increasingly forced to tighten policy to restrain inflation, but are constrained by the risk of provoking much higher unemployment or chaos within financial markets. As investors, we are no longer able to assume that positive returns come without the risk of heightened volatility and that central banks have our backs. Nor can we rely on our fellow investors to step into the market and purchase what we wish to sell.
All of the above provokes uncertainty and a feeling of instability. When one considers that just a few years ago it was possible for a historically unstable country such as Austria to issue a sovereign bond for longer than the reign of Queen Elizabeth for a yield of 2.0%, whereas now a UK government can last less time than a salad, this is quite a change over a short period of time. As the yearly calendar turns another click, we would prepare for more strange times ahead.
