Blain's Morning Porridge - Nov 2 2017. The Wall of Debt that may tumble and crush us as rates no

Blain’s Morning Porridge – November 2nd 2017

“I don’t wanna be a candidate for Vietnam or Watergate, ‘cause all I want to do is…”

For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…

Interesting day ahead as we await for Mark Carney’s mumble-swerve comments following the first hike in UK interest rates in 10 thousand years. We have the fireworks ready, and just in case, some buckets of sand to pour over excited spectators should they spontaneously combust.

Yesterday’s Fed statement – likely to be the last one before La Yellen becomes a lame duck – raised US growth to “Solid”. It confirms the likelihood of a hike to come. This is it… Coordinated Aligned Global Normalisation. Get used to it. This is the new new reality.

With many economists now saying the US economy is soaring, and could hit 4% growth, are we discounting the likely pace of hikes next year? The market liked the (now old) “new normal” scenario of slow, gradual normalisation with one hike next year, and maybe another after that.

What if it’s more aggressive – and rates rise more rapidly as wage price inflation returns? Are we likely to suddenly wake up to a reality the last 10-years of austerity, zero-rates and monetary experimentation didn’t build solid foundation, but that cheap rates have created an even less stable and more shaky “Walls of Debt”.

My colleague, stock picking US watcher Steve Previs reminds me I’ve got three things to worry about: a serious $3 trillion of US credit card, auto and student loan debt all looking wobbly and likely to implode. If consumers can’t consume because they are i) broke, ii) can’t get credit ‘cos we broke the credit system again, then the economy is going to slow.

I suppose the upside is no consumption means we won’t have to worry about inflation….

I’m just as worried about the corporate sector where the pace of private equity acquisition means more and more companies are over-levered and will struggle to invest in capex or growth to fuel growth, or will go bust as rates kill them.

Will a faster pace of rate rises trigger crisis across heavily leveraged borrowers in both consumer and corporate sectors, crushing sentiment in stock markets and triggering the next big recession?

That’s three risks to consider: 1) the decompression trade as corporate, hi-yield, EM etc suffer as rates rise and the bond slide deepens, 2) a consumer loan shock on banks, and 3) the return of inflation if a debt crisis is avoided! (Crashing minor chords in the background) I’ve been looking at new exciting ways to play inflation in sterling (including a housing play), and we’ve got a couple of interesting Euro inflation trades for anyone interested. Get in touch if you want more!

As I wrote last week; we do believe we’ve passed the top of the long-term 60 year bond cycle, and we’re now into the next bear phase – rising rates. (I’ve re-attached the graph for your perusal.)

Well.. none of the above is particularly positive first thoughts for this beautiful bright morning…

Back to Blighty.

There are folk in the office who were at primary school last time the Old Lady raised the Base Rate. How terribly exciting it will be for them this afternoon. Are we going to get traders scurrying round the office screaming doom and gloom, or investors tumbling from the 28th floor? I somehow doubt it.

I, for one, will bow my head and wish the bull market a fond farewell.. Huh.. 25 basis points.. That’s Nothing! I remember Black Tuesday when Chancellor Norman Lamont raised rates about a billion percent one sunny September afternoon just because he felt like it. (Actually, he raised them 2% from 10%, threatened to raise another 3%, and thought: “f*** it, this is pointless, no one is listening… we’ll exit the ERM (European Exchange Rate Mechanism) instead.” His incisive moves means posterity will recall Lamont as the man who ultimately doomed the Euro and is ultimately responsible for Brexit.)

I was asked yesterday – why will the BOE take the risk? The obvious one is the apparent tightness in the labour market. You could also raise the inflation genie. At the back of their minds will be the sterling vs inflation trade off – despite the crashing pound it’s not exactly created an exports boom, so why not generate a bit of consumer feel-good by hiking sterling?

However, a rate hike now could trigger an important psychological shift: while rates have been close to zero they’ve acted as a perverse investment disincentive as entrepreneurs judge the economy to be stagnant, returns to be too low to take real economy risk, and focus on financial risk instead. The result has been financial asset inflation in bonds and stocks as money has chased money in search of higher than base returns. One obvious effect has been companies opting to buy-back stock rather than invest. Raising rates sends a critical signal about “normalisation” – supporting the resumption of real capital expenditure investment across recovering economies.

Meanwhile, back in the real work, I’ve a happy morally superior smile beaming across my fizzog after a stand-off with a cyclist this morning. He comes spinning round the corner from my flat ringing his bell, nearly hits me on the path and starts screaming at me to get out the way. I stare at him and say: “This is the Thames Walkway – it’s not a cycle path. Stop ringing your bell – its waking the residents. And, why don’t you go use the very expensive cycle path across the road instead.” I walk past him and he starts swearing at me.

My brilliant and utterly devastating response is to turn around and smile at him.

I bet it utterly ruined his day…

Out of time and back to day job..

Bill Blain