Bedrock’s Newsletter for Friday 2nd of August, 2019

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 Friday, 2nd of August 2019

“Never trust a computer you can’t throw out a window.”
– Steve Wozniak

 

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Equity markets witnessed a twin-legged sell-off this week. The first came on Wednesday evening after Fed Chair Jerome Powell announced the first policy rate cut since 2008 but cautioned that this was not the start of some deep rate-cutting cycle, which many investors and traders thought likely. We argued last week that Mr Market tends to indulge in myopic swings from one extreme to its polar opposite and was being unrealistic to have priced in such a rapid and precipitous fall in rates when no such thing had been telegraphed by the Fed and US growth was on trend. In the event our forecast proved accurate, and the impact of Powell’s decision was instant – the S&P 500 Index fell more than a point on the news, before rallying into the close, while US short-end rates climbed sharply and drove a flatter sovereign curve. A barrage of Presidential tweets soon followed as the Donald berated the Fed for not proposing future rate cuts and thus, in effect, not coordinating US monetary policy with his short-term political aims and 2020 re-election bid. Disagreements between US Presidents and Fed Chairs are nothing new in American politics, but to have them play out in public is new, given the need to maintain the credibility of central bank independence. We are therefore pleased to see Powell holding the line and following the data. However, notwithstanding that fact, the Fed Chair has been pretty poor at managing expectations in his admittedly short stint at the helm of the US central bank, giving statements and guidance that are often misinterpreted or have to be walked back in subsequent weeks. When markets are driven by your every waking breath, communications skills are as important as macroeconomic credentials…

 

The second leg of the sell-off, which came on Thursday afternoon, was more pronounced than the first and saw no immediate recovery in its wake. Indeed, the scale of the bond market rally has caused the whole German sovereign curve to fall below zero, where it joins the Swiss curve in uncharted territory. The collapse of sentiment was caused by the US President, who announced that a 10% tariff would be raised on a further $300bn of Chinese imports from 1 September. In comments immediately before he held a rally in Ohio, President Trump also suggested that the tariffs could be raised to 25% or beyond if China continues to drag its feet in negotiations. This represents a major escalation of trade tensions between the two economic superpowers and threatens the fragile truce that has prevailed since the G20 Summit in late June. At the G20, Trump and Xi agreed to resume high-level talks, but the timetable slipped in July as US officials weighed various Chinese demands, including for them to lift restrictions on Huawei in advance of in-person meetings. There were surprisingly few leaks of what was ultimately promised to reboot the talks this week, but the US is thought to have sought a comprise in which Huawei would be part of the final trade agreement if China bought more US farm products in turn. Trump’s latest salvo suggests that China did not get the memo – or sought rather different terms when the two sides sat face-to face. Beijing has now promised countermeasures but has failed to give any specifics. Earlier this year, President Xi hinted that China would consider restricting the export of rare earth metals to the US if Uncle Sam escalated the trade war beyond China’s capacity to respond through traditional tariff means. Given the breadth and scope of US tariffs already in place, and the size of the US trade deficit, it is hard to see how China can match these new US measures in a like-for-like fashion. A ban on rare earth metal exports to the US is the country’s nuclear option because it would weaken the trust that underwrites China’s monopoly over these vital minerals. However, if US tariffs shoot up to 25% or more, China will have few alternatives if it wants to avoid a humiliating climbdown.

 

Over in Europe, UK PM Boris Johnson’s Brexit strategy has rapidly taken shape, after a ruthless Cabinet cull in the wake of his victory in the Tory leadership election on 24 July. All of those now in senior Cabinet positions are committed Brexiteers or Hard Brexit converts who agree that ‘no deal’ is an acceptable outcome on 31 October should no alternative be found to the so-called ‘Irish backstop’. PM Johnson is demanding that the backstop be eliminated from the Withdrawal Agreement and has refused to discuss Brexit with the EU unless they agree to re-open the document (seeing it as pointless given the opposition to the deal in Parliament). In the meantime, he has ‘turbocharged’ preparations for ‘no deal’, ploughing $2bn into efforts to ensure as smooth an exit as possible on Halloween, whatever the circumstances. Thus far, EU officials have refused to alter the controversial backstop provisions in any way and are insisting that the current deal is the only and best one on offer. However, they are no longer dealing with Mrs May, who never once suggested that the UK was ready to exit the block without a deal (unlike in her public pronouncements where she courted Leave votes). PM Johnson is committed to leaving the EU and faces significant domestic political pressure to deliver on the referendum result. The Conservative Party has lost many of its core supporters to the single-issue Brexit Party led by Nigel Farage, which is demanding ‘no deal’, while a group of backbench MPs from the European Research Group have hinted that they will not back the Withdrawal Agreement ex-backstop solution that the PM clearly wants. Given that the Conservative majority is wafer thin and includes the support of the Northern Irish DUP, who are implacably opposed to the backstop, there is zero chance that the Withdrawal Agreement can secure the backing of Parliament in its current form. Unless the EU move then the two sides are heading for ‘no deal’. This realisation has begun to take hold in parts of the Irish press where cracks are showing in the once broad support for Taoiseach Leo Varadkar’s tough stance on the backstop. Afterall, it would be rather ironic if the backstop protocols designed to avoid a hard border in Ireland at the end of the transition period scuppered the deal at the outset and led to just such a border in the Autumn. Traders are also waking up to the UK’s new Brexit strategy, with the pound now trading at its lowest level since 2017. As things stand today, the probability of ‘no deal’ has never been higher and the UK is getting ready. Maybe this will focus minds… that appears to be Johnson’s plan.

 

In other news this week, a 16-year-old boy has won the $3m grand prize at the first-ever Fortnite World Cup. For all the ‘noobs’ out there, Fortnite is an online survival game that has taken the world by storm – and been banned in China and Iraq. The game is so addictive that it has even been cited as a factor in 200 divorces in the UK since January 2018, according to research by divorceonline.co.uk. The new global champion, Kyle Giersdorf (who we assume has no marital commitments to worry about), trained for six hours per day in the run-up to the competition, but has been playing video games since the age of three. He is a talented virtual athlete who has followed his dream to the big leagues. Now, having secured his crown, Giersdorf plans to “save the money and invest it and not do anything dumb with it”. Well done, sir.