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The cliche is that the markets climb a wall of worry. But sometimes worry wins, and for good reasons.
After a sharp two day rally, Chinese stocks swooned, triggering global stock and stock futures market selloffs. Investors like to explain why markets do what they do, which is why many reportedly use psychics and astrologers. There are plenty of reasons for fund managers to think of lightening up on risky assets, such as nosebleed valuations across all major asset classes in a very long-in-tooth “recovery” while central banks are tightening (as in the US) or at least no longer engaging in monetary stimulus. And that’s before factoring in that private debt levels are high around the world and all sorts of authoritative bodies like the IMF and Bank of International Settlements have talking up crisis risk, which is out of character for them. So that would be enough to make money managers trigger happy, even before getting to the fact that it’s October.
The overnight news reports suggest that so the spectacle of so many serious-looking situations precipitated the selling. In China, even though the government launched a new stimulus program, asset holders fret that it won’t be enough to compensate for the damage that a US-China trade war could inflict. And recall that outsiders have ben concerned about a crisis for years in the face of massive investments in un or underproductive assets and more and more debt needed to produce an additional dollar of GDP growth. From the Financial Times:
China’s main equities indices went into sudden reverse on concern that government policies to boost its economy will be offset by the impact of its trade dispute with the US. Mainland China’s CSI 300 closed down 2.7 per cent, with declines for every sector on the market. It represented a sharp reversal from Monday’s rally of over 4 per cent….
“The geopolitical whipsaw just keeps on coming . . . and its getting harder and harder to keep track of all of the issues that are out there now,” said Brad Bechtel, managing director at Jefferies.
“Talk from Steven Mnuchin, the US Treasury secretary, that he might be open to changing the way the US evaluates currency manipulators is not helping the cause for China. The US keeps ratcheting up the pressure and China keeps responding any way it can. I don’t see this dynamic changing anytime soon.”
Analysis from Société Générale said that while Beijing’s efforts to boost confidence — which included speeches by top officials, tax cuts and funding for local governments — were “striking the right tone”, China’s falling current account balance meant more changes will be needed.
As of this hour, the DAX was down by 2% and US stock futures were off by roughy 1%.
Italy and the EU are in a staredown. As readers likely know, Italy wants to run a budget deficit of 2.4% of GDP next year and forecasts that the deficit level will fall because growth will improve. If anything, Italy’s proposed deficits are too small relative to the slack in its economy. Even though the EU has often let countries break budget rules and not put up a stink, its rationalization of why it is getting tough with Italy is that Italy has a high debt load, at ~ 130% of GDP. However, the fact that Italy has an upstart populist government and it won a fight with the EU over migrants (recall its refusal to let ships carrying immigrants land in Italy) probably plays into the EU playing hardball. As our Colonel Smithers noted in a recent comment, French and German civil servants and bankers at a recent conference were sympathetic with the Italian government’s stance on running a deficit. As he put it:
The German and French contingents agreed with their Italian counterparts that failure to cut Italy some slack would put the EU/Eurozone project at risk, but felt that the politicians and other elites benefitting from the current set-up would not countenance such heresy.
As so often happens, the wrong people are in the driver’s seat. From a different Financial Times report:
Italy’s populist government defied eurozone budget enforcers on Monday, refusing to curtail its plans for a sharp increase in public spending and insisting that breaking the EU’s fiscal rules would not threaten the currency union’s stability…
[Economics minister] Mr [Giovanni] Tria wrote that challenging Brussels’ request for changes to the budget “was a hard, but necessary decision in light of Italy’s delay in getting back to pre-crisis levels of GDP and the desperate economic conditions in which the most disadvantaged citizens find themselves”.
Rome’s refusal to budge marks the first time a member of the common currency has ignored a formal reprimand from Brussels since EU fiscal rules were overhauled at the height of the eurozone crisis.
It also sets Italy’s governing coalition on a collision course with the commission, which is expected on Tuesday to demand Rome resubmit its 2019 budget, an unprecedented move from eurozone authorities. If Italy fails to comply, it faces millions of euros in fines. The commission declined to comment other than to confirm it had received Italy’s response.
Investors have been watching the stand-off warily, with borrowing costs on Italian debt returning to near four-year highs on Monday after Mr Tria rejected EU entreaties. The benchmark 10-year bond had briefly rallied earlier in the day after a Moody’s downgrade stopped short of pushing the debt into “junk” status. But the bond pared those gains later in the day, hitting an intraday high of 3.53 per cent.
The higher bond yields mean bigger interest costs and thus a larger budget deficit. Back to the story:
Moody’s reduced Italy’s rating by one notch to a level above speculative status, or “junk”, after trading hours on Friday. The agency also restored its outlook to stable, from negative.
Some investors had feared that Moody’s could cut Italy’s rating by more than one notch, or leave its outlook as negative — a signal that the eurozone’s third-largest economy was on track to slip into junk status.
Financial Times reader Larchmont pointed out:
This is a political row. The projected deficit isn’t eye popping, several other members are in the same ballpark and debt levels generally have remained obstinately high. Bottom line the EU is appalled at having a “populist” government in Rome, especially as they may be the key votes for Juncker’s replacement…The budget must have seemed the perfect opportunity to even the score. Having made it an issue, the EU is now faced with backing down or a show down with all the instability that could bring just when it has its hands full with Trump, Brexit, V4, China, EP elections, Fed tightening etc.
Another cause for pause is Saudi Arabia. Mohammed bin Salman’s many outside the pale actions, such as rounding up and imprisoning 400 Saudi royals, including the well-connected Al Walid, the one-time rescuer of Citibank, in order to shake them down, and the detention of Lebanon’s prime minister Saad Hariri did get press reports, but shockingly little in the way of outrage or pushback. Why the brutal murder of Jamal Khashoggi has become the cause for pushing for the ouster of Mohammed bin Salman is an open question, although killing him in the embassy in Turkey does allow Turkey to fan the fire, which it is doing with great relish. From DW:
Turkish President Recep Tayyip Erdogan told lawmakers on Tuesday that Turkey had “strong evidence” the murder of Saudi dissident journalist Jamal Khashoggi was planned in advance by Saudi officials, contradicting Saudi accounts that the journalist died accidentally in a “fistfight” in the Saudi consulate in Istanbul….
What did Erdogan say?
– Turkey has strong evidence that Saudi officials planned Khashoggi’s murder days in advance.
– Saudi team visited forest in Istanbul and Yalova before Khashoggi’s disappearance on October 2.
– Consulate security cameras were removed.
– A day before the murder, a number of forensics, intelligence specialists arrived in Istanbul
– A Saudi team of 15 entered the consulate on the day of Khashoggi’s murder.
– Eighteen people arrested in Saudi Arabia in relation to the murder matches those identified by the Turkish intelligence.
– Khasoggi was killed in a violent, savage murder.
– He had no doubt to question the integrity of the Saudi King.
– The issue of diplomatic immunity under the Vienna Convention would be discussed in regards to the case.
– The suspects should be tried in Istanbul and not in Saudi Arabia.
Only Turkey knows: Turkish Foreign Minister Mevlut Cavusoglu said hours before the speech that Turkey had not shared any information about the case with other countries. He added however that Ankara would be willing to cooperate with an international probe. Saudi Foreign Minister Adel al-Jubeir told reporters that such a killing must “never happen again” and promised a thorough investigation into Kashoggi’s death.
The wee problem is that MbS would be very difficult to dislodge. He did a very fast and effective job of seizing control of the internal security forces and imprisoning or marginalizing rivals. Historically, Saudi Arabia has had its kings rule with the informal consent of factions within the royal family, with family councils having a lot of input. MbS shut down the councils and has succeeded in making himself much more of an autocrat than past kings. And it isn’t as if the US has a great track record with backing Middle Eastern “moderates” trying to oust national leaders.
And then we have Brexit. In Parliament on Monday, Theresa May stuck to her guns on trying to get an extension to the transition period, even though the DUP plus every faction in her own party is opposed, and the Shadow Chancellor trash talked it too. Oh, and the members of the EU Council didn’t discuss it either in their dinner after May’s talk, at least according to Donald Tusk. So May looks to be firing up a steam engine when none of the cars of the train are attached to it.
So there’s a lot to rattle the nerves. But since we are in an overly dynamic situation, who knows what happens next.