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I am braced to spend the rest of the week writing about central banks, as the world’s three largest are due to take turns to make announcements on how they propose to continue to remove the props they have been providing for the money market. What might stop them?
The answer to that would be "financial stress" writ large. Central bankers have lived in fear for the past 10 years of making a misjudgment, pulling off support too quickly, and bringing the banking system down in crisis once more. They will be determined to avoid this. And that could yet prompt them to stay their hands on tightening monetary policy — which would in turn be good news for both stocks and bonds, but could inflict pain on the many who are positioned for bonds to go down in value (and hence for their yields to rise).
As it stands, markets appear to have recovered from the recent fears driven by Italian politics, and by developments in some emerging markets. The chances of rate rises from the Federal Reserve are now seen as about as high as they have been all year:
However, they may be overlooking a key source of stress. In the wake of the crisis, the world’s financial regulators decided that they needed to nominate a select few GSifis (Global Systemically Important Financial Institutions). Because these groups were so systemically important, at least with their own markets, they would need to be regulated more tightly than other banks or insurers.
This might reduce their profitability but would have the key advantage for potential investors that they would be almost certain not to crash. In the phrase everyone learned 10 years ago, they were Too Big To Fail.
Of late, an institution’s systemically important status seems to be seen as a weakness. If we take all the GSifis, and there are only deemed to be 40 of them on the planet, and weigh them by market cap (so as not to overstate the impact of some sharp recent falls for relatively small European institutions), then the team at London’s Absolute Strategy Research show that they are in a bad state. From the top of the market on January 26 until May 31, they collectively lost $800bn in market capital, or about 18 per cent. That is virtually a bear market. As the chart shows, GSifis have continued slipping away while the S&P 500 has staged a decent recovery and the tech-heavy Nasdaq Composite has set new records:
A look at the full list shows that this cannot be dismissed as only a eurozone problem, as Chinese and Japanese banks are participating to the full:
To look at this in more detail, the US banks enjoy far more confidence from equity investors than do banks in the rest of the world.
Banks in the US seem to have maintained confidence to a much greater extent than global banks as a whole:
Can this be seen as primarily a collection of idiosyncratic problems for particular institutions, rather than a systemic one? With Italian banks stressed by political events at home, and the seemingly intractable worries about the health of Deutsche Bank, it is tempting to say so. This is how the market values in dollars of Deutsche and JPMorgan have compared since 1998, a period in which both made a number of huge acquisitions:
Some specific institutions have specific problems, while others, for specific reasons, seem relatively immune to them. However, ASR points out that the loss of confidence in the GSifis overlaps closely with a decline in the global real money supply. In other words, it could reflect a shortage of dollars.
Alternatively, the move away from the equity of GSifis could reflect concern over widening credit spreads, which have started from a very low level. Eurozone asset managers are particularly heavily exposed to US credit, arguably because the European Central Bank has given them little choice but to look abroad to take risks.
ASR’s very bold call is that US 10-year Treasury yields will hit 2.5 per cent before they reach 3.5 per cent, because a fall of 15-20 per cent for the GSifis has typically seen 10-year yields dip by 50-100 basis points. That is not consensus. It would put the cat among the pigeons and hurt a lot of people who have been betting against Treasuries if this were to happen, although prop up stock markets nicely.
More cats among pigeons
The Trump Administration has had some surprising diplomatic turns of phrase of late. We now know that the prime minister of Canada is “very weak and dishonest” while the supreme leader of North Korea is "a very talented man”, who “loves his country very much”.
These are surprising views. Meanwhile, under the radar of many people as other global situations play out, Mexico is within weeks of going to the polls. The latest poll of polls, as collated here by UBS, shows that barring something extraordinary, Amlo (Andrés Manuel López Obrador, virtually always known by his initials) will be the next president, and the first president for an avowedly leftwing party under the country’s current constitution. Mexico only has a one-round presidential election, and Amlo is now topping 50 per cent in the poll of polls:
Amlo, a former popular mayor of Mexico City, was the standard-bearer for the left at both the past two presidential elections in 2006 and 2012. He has a lot in common with Brazil’s former president Luiz Inácio Lula da Silva when he came to office in 2002, and this goes beyond a two-syllable nickname. Lula had also been a perennial candidate, with extensive experience as a union leader. Both men are strongly on the left, but do have the ability to manage. Running Mexico City is a daunting task, and Amlo was equal to it. All of this is positive, as Lula’s election in Brazil in 2002 created one of the greatest buying opportunities of recent history. Buy Brazilian stocks on the day he won, and you made a scarcely believable 2,000 per cent in little more than five years before the market finally turned.
But Amlo is also, like Lula, an ideological left-winger in a country with a deep and endemic corruption problem; he has shown very distinct autocratic tendencies; and, unlike Lula, he is critically exposed to a huge and now unfriendly neighbour. On the face of it, he could find himself lined up for the Trudeau treatment, and miss out on the more preferential treatment meted out to friends of the US like Kim.
At this point, there is little uncertainty over the result in Mexico. Barring a very major upset, Mexico will have President Amlo, without a majority in Congress. And stock markets have priced in bad news for Mexico:
Markets were terrified of Lula before his election. That created the buying opportunity. There is no way that Mexico can repeat what happened in Brazil after 2002. But the sheer range of what could result in Mexico is baffling. How exactly will a wily populist Mexican politician choose to engage the country’s neighbour, and how will Mr Trump choose to respond? Can these two men possibly find a way to communicate with each other? It will be fascinating, it will have a huge impact on the still widely impoverished population of Mexico, and the effect for foreign investors could also be profound.
To muse on the many varieties of lies we tell each other, the difficulties of human relationships, and the dangers of merciless dictatorships, you might try this song by Mana, Mexico’s most popular rock band, joined here by a pregnant Shakira: