commentary

authored by

John Kierans
December 2018

I am writing this on New Year’sEve. Less than two weeks ago the FederalReserve indicated that it would hike interest rates by 25 basis points two more times next year.  However, today the market is pricing no increases in 2019 and a cut in rates in 2020. That is an extraordinary turnaround in the market and indicates severe stress in markets.

The market is addicted to negative real (and nominal) interest rates and money printing.  It appears to be unable to handle the withdrawal of both stimuli.  For example Steven Mnuchin, the US Treasury Secretary, held calls with the heads of the six major banks on the Sunday before Christmas.  The purpose of the call according to CNBC “was to shore up confidence in the US financial system amid recent market turmoil”.  It appears as though the US government worries about the ‘US Financial System’ when the stock market moves down.  Trump weighed in on the market pre-Christmas turmoil in his usual style.

“I think it’s a tremendous opportunity to buy.  Really a great opportunity to buy.”
– President Donald Trump, Christmas Day 2018

I think Trump will be unable to say anything to calm markets in a crisis situation.  He is an incendiary device himself.  The above comment is hardly reassuring.  Even Bush was better than that. To boost the stock market, Trump will need more than words.  He will have to ‘do stuff’.  I think he has two bullets left in his chamber.  First, he will declare victory in his trade war with China and move on.  That would be an easy piece of theatre for him.    The second bullet involves forcing or cajoling the Federal Reserve to reverse course.  I simply don’t know the outcome here other than to say that this bullet could back-fire.

Trump will play an important and arguably decisive role in next year’s economic turmoil.  He is a very unique political leader and a man of action.  With a different incumbent in the Oval office the United States could hope to stumble on a little longer like Japan has.  Apparently Trump is a notorious micro manager and clearly he needs to be at the centre of things.  He needs to be the star of the show.  Like him or hate him, he will play a starring role in any forthcoming financial turmoil and it will be a destructive role.

The ECB is bust

The ECB’s subscribed equity capital is €7.74 billion.  It has a €414Bn balance sheet.  This gives an operational gearing on core capital of 53 – fabulous!  A 2% downward move in the price of all of those wonderful government and corporate bonds that it owns and poof….it will need to be re-capitalized.

Europe’s major banks are teetering on lifetime low share prices.  After all the rescues and bailouts their share prices recovered in 2010 only to slide lower again.  The chart below shows the share price performance of Deutsche Bank.  The pre-crash high was €91.  It fell to €13 and then recovered to €46.  It has since fallen 85% to €6.75.

Commerzbank is also down 85% for the same period.  Italy’s Unicredit is down 88%.  Spain’s Santander is down 66%.  After all that pumping by the ECB nobody appears to be better off.  We appear to be very close to another crisis.

All that actually happened after the financial crash is that we created more debt.  That’s it.  We are back were we started, only this time with bigger numbers.  The politics in most countries has become a lot less cooperative which may make resolutions and bailouts a little more difficult.

Conventional investors have enjoyed the central bank induced rallies in stocks and properties.  They will be hoping that government bureaucrats (central bankers) will protect them from another crash.  But hope is no substitute for a plan.

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