Political Shenanigans Make For Spicy Start To The Week

WHERE WE STAND – A penny for the thoughts of G4 central bankers right now, as none of them appear to have particularly easy jobs.

First, Fed Chair Powell, who recently resumed the journey back to a more neutral setting of the fed funds rate, only for the ongoing government shutdown to now leave Powell, and his FOMC colleagues, ‘flying blind’ amid a data void, which makes judging the true health of the economy rather difficult, to say the least. Not forgetting, of course, ongoing political intervention in monetary matters, and the erosion of policy independence amid near-daily comments from President Trump.

Next, ECB President Lagarde, who must deal with yet another episode of political pantomime in her home country of France, after the surprising resignation of PM Lecornu yesterday. For those keeping track, he lasted just over half the time that Liz Truss did as UK PM in 2022, which I’m sure isn’t a milestone he’ll want to be reminded of. Anyway, the main market fallout here continues to be seen in FI, with the OAT-Bund spread hitting new YTD wides at 87bp, and the EUR stumbling a bit. Of note for the ECB is that spread, though, where a further widening may well begin to undermine monetary policy transmission, perhaps meaning that the ECB is here to close spreads after all.

Then, there’s BoJ Governor Ueda, who seems desperate to tighten policy further, but for whom a spanner is continually being thrown in the works. First, it was political uncertainty amid upper house elections, then trade uncertainty ahead of a US-Japan deal being agreed. Now, it’s the election of a new LDP leader, and Prime Minister, in the form of Takaichi, who could scupper things, given her well-known and incredibly vocal opposition to the BoJ hiking rates, chiefly as a result of her preference for a much more expansionary fiscal policy.

Last, but by no means least, we have BoE Governor Bailey, who must not only grapple with inflation running at as near as makes no difference double the MPC’s 2% objective, and the late-November Budget which is near-certain to bring with it stiff growth headwinds in the form of a further round of substantial tax hikes. Bailey & Co find themselves stuck between a rock and a hard place, wanting to ease more rapidly to support ailing economic momentum, while being unable to do so as a result of sticky price pressures.

I guess all this throws up a couple of questions.

Initially, who’s got the hardest job? I’m not entirely sure I’d be keen on swapping places with any of them, in all honesty, especially when considering that a big chunk of those issues are political in nature, and thus much more difficult for a central bank to solve.

The second, and more important question, is how markets might trade all of this? I’d argue that, by and large, what we’ve seen in recent sessions is broadly representative of how all this should shake out going forwards. Namely, weakness at the long-end of the OAT curve, weakness at the long-end of the JGB curve, and weakness at the long-end of the Gilt curve – no prizes for spotting a theme there! In FX land, meanwhile, the JPY is likely to soften further amid a dovish repricing of BoJ rate expectations, though the 150 figure seems like it’ll be a tough nut to crack, while the EUR and GBP should face headwinds too. Chuck some gold into that mix too, for a momentum play if nothing else, with bullion printing $4,000/oz a question of ‘when’ not ‘if’.

Amid all that, we must return to the idea of the ‘cleanest dirty shirt in the laundry’, which is once again the greenback, which not only stands to benefit from the frankly shambolic nature of things everywhere else in DM, but also from the Fed’s ‘run it hot’ approach, which now tilts risks to the US economic outlook, and thus the dollar, firmly to the upside. The DXY reclaiming the 50-, and 100-day moving averages in yesterday’s trade will have got the technicians excited as well, and could now see the buck kick on even more.

Something that needs absolutely no help whatsoever to kick-on, meanwhile, is the equity market, with stocks on Wall St gaining once more yesterday, led by the tech sector. Of course, this has led to the ‘usual suspects’ continuing to scream that stocks are ‘expensive’ right now.

To say that the S&P is ‘expensive’, though, is basically to say that the ‘Magnificent Seven’ are ‘expensive’, given that the make up 35% of the benchmark. To say that group are ‘expensive’, though, is complete and utter nonsense given that, perhaps with the exception of Tesla, all are valued – per the 12-month forward P/E ratio – pretty much bang in line with their 5-year average P/Es. If you’re now about to tell me that they’ve been ‘expensive’ for 5 years, well those 7 stocks have delivered a total return of >300% in that period of time, and look set to rally even further in the coming months.

In fact, the ‘path of least resistance’ for the market at large continues to lead to the upside, as earnings growth remains strong, the underlying economy remains resilient, and as the monetary policy backdrop becomes increasingly loose.

With each passing day, I become more convinced that we’ll all be rocking “Spoos 7k” baseball caps (or gilets!) before year-end.

LOOK AHEAD – The data vacuum continues today, with no especially notable releases on the docket, and focus remaining on political developments – not only the impasse on Capitol Hill, but in Paris & Tokyo too.

As for the docket, we do have plenty of central bank speakers, including a couple of appearances from Fed Governor Miran, which should be good for comedic value if nothing else.

Besides that, only a $58bln 3-year Treasury auction is worth keeping an eye on, though that supply should be digested with relative ease, with tomorrow’s 10- and Thursday’s 30-year sales of considerable more interest.