A belated good morning from Jakarta where I am on day two of managed isolation and where, unfortunately, my hotel room’s internet ceased functioning last night. Back home in New Zealand, it’s been nearly two months since I looked at the markets closely, but the effects of the pandemic behind the Great Wall of Jacinda have been clear to see and most certainly have played out similarly in other parts of the world.
The ham-fisted quantitative easing by the Reserve Bank of New Zealand has caused one of the greatest wealth transfers in the country’s history as asset prices headed into space. I was also shocked by the increase in the cost of living which can’t just be explained away by “the pandemic.” I have spent the last two months describing New Zealand as Norway prices with Nigerian salaries. Having grossly overheated the economy, the RBNZ now faces the problem of putting the genie back in the bottle, painfully. I expect a 0.50% rate hike this week and some bashful dovish backtracking. February 2022 could be the lowest we see the New Zealand dollar for a long time.
Elsewhere, it appears that the usual “kitchen-sink” trade that usually starts the year has already played out and reversed. By this I mean that in my experience, markets usually walk into the office on January 3rd, feeling like they need to do “something” to start the new budget year. With a new budget year, the financial market group-think kitchen sink is then thrown at the trade, which works well for the first month as the herd joins in. That is followed by two to three months of being painfully squeezed out, leaving everyone square and scratching their heads by Q2.
This year the street finally listened to me and decided that rising interest rates, notably by the Federal Reserve, were a reality. The “buy everything” 2020/21 trade promptly tanked; led by stocks, cryptos, EM, and the US dollar rolled over FX markets like a Russian tank lost in Belarus. Gold and oil went bid and stayed bid, more on that later. The trade ran out of momentum in early February and sure enough, the street appears to have been squeezed out of a lot of it, even before March, leaving many asset classes in a “what now?” state.
I suspect the US yield curves refusal to price in inflation-for-longer is the main culprit, and let’s face it, there is still plenty of cash out there looking for a home as well. Although the US yield curve has moved higher as the reality of a tightening Fed threw buckets of cold water on the” cost of capital is zero per cent forever” gnomes, the long end of the US curve has refused to buckle to the inflation worries. Duration and liquidity play their part I agree, but 20-year and 30-year yields are still only 27 and 14 basis points higher than February 2021. Someone is going to be horribly wrong here at some stage.
My two months in New Zealand have left me with a sinking feeling that inflation is going to be higher and around longer than the market’s complacency/hope/group-think would have us believe. And let’s face it, a lot of governments could use a few years of inflation to inflate their pandemic borrowings away, nothing written on paper of course. That realisation and an ensuing move higher in longer-dated yields could be the schism that sees another big leg down in stocks and cryptos.
I very much doubt we will see inverse yield curves anytime soon. Nothing the Sackler Family produced has been as addictive as QE to many major central banks, notably the ECB and the BOJ, with the Fed not far behind. What should have been a last resort and tactical policy for global emergencies has become a fait accompli to keep the global asset price party rockin’, and to allow global investors to never have to take a loss, no matter how dumb the investment decision. I have no doubt that some evolution of backtracking will appear soon thereafter.
Two markets where prices have not retreated to any extent are oil and gold. That likely serves as a warning signal. A rapidly reopening world where omicron is omi-gone, unless you are Mainland China, Hong Kong or New Zealand, is supporting oil prices. More open borders, travel and overseas holidays are on the way, virus be damned. Sadly also, I have been right on the seriousness of Russia’s “exercises” on the Ukraine’s borders. Oil is unlikely to fall in this environment and it is a fertile ground for gold as a haven as well. Something Russia and China have been accumulating plenty of over the past decade. Gold’s refusal to roll over as global yields rise is a huge signal that many investors are nervous and can’t be explained away by such things as the India wedding season demand.
I have said repeatedly that 2022 would be a year of a lot more two-way price action that would make investors’ honest for the first time in years. The “buy-everything” trade is dead, long live the “buy-everything” trade. That certainly seems to be how it is playing out already and I expect to hear a lot more HODL’s in the Reddit forum and crypto space. In my day, HODL was a handy English footballer, now it’s hold on for dear life. There is only one gold element, but seemingly more cryptocurrencies than there are fiat national currencies. They can’t all supplant the current financial system. When I start hearing the word “blockchain” used by the sector, something missing in action for years, I’ll maybe start taking them seriously. In the meantime, the more HODL’s I hear, the happier I will be knowing there is just one gold.
By the way, a Russian invasion could be good for stocks. Yes, you’d want to sell everything European as 40% of its gas supply gets cut off, and yes, Brent crude will probably trade as high as $150 a barrel. Gold will make new all-time highs, the US Dollar will leap higher, and equities will get blasted initially. But on past form, the world’s central banks will immediately respond with a massive easing and a flood of liquidity. If this sounds familiar, it is, have a look at the GFC and March 2020 and the price action that followed.
In the short-term, expect markets to bounce around on Ukraine/Russia headlines. The biggest risk to Russia right now is probably that Vladimir Putin laughs himself to death at the Western response, but any “talks” headlines should spur straw-grasping rallies in markets.
