Deutsche Bank’s Aleksandar Kocic has done it again.
Regular readers know Kocic. He’s the derivatives strategist who has a penchant for penning stream-of-consciousness-style missives about markets. Perhaps most notable (or at least on my end) was Kocic’s characterization of the Fed’s reflexivity problem as the “removal of the Fourth wall,” a nod to theatre.
Although Kocic’s notes are probably a bit too metaphysical for some, the fact is he’s a really good writer, something that doesn’t seem to come natural to most sell-side strategists (and a skill that’s deteriorating over time among some previously celebrated commentators). You can read his take on populist “buyer’s remorse” here.
I was waiting on the right time to highlight his latest piece (out last Friday) and I think the hand-wringing over Trump’s tax proposal as well as the game of chicken Capitol Hill has been playing with the White House with regard to the government shutdown provides just the opportunity.
Read below as Kocic expounds on fiscal policy, natural laws, and Wile E. Coyote.
Via Deutsche Bank
Our heads are round so our thoughts can change direction
While monetary policy has shown remarkable flexibility when it comes to innovation and adaptability to different market conditions, fiscal policy has remained rigid and resistant to change. This state of affairs is largely a function of the institutional differences of the two and, to some extent, long-term secular trends. The distinction is predominantly due to vastly different inertia the two policies have: Fed as a 12-member structure requires a much lower level of consensus than is needed for any material fiscal change with more than 500 members of the Congress and the constraints defined by the Constitution. These differences are unlikely to change irrespective of political initiatives, rhetoric and promises, be they centrist or populist. There appears to be only one way of running the political theatre with no maneuvering space and little tolerance for deviation from the script, no matter how unpopular that might be. When viewed in the context of other policy tools, the inevitability of the fiscal inertia is a fact of life, like a natural law, that despite all resistance, the market will have to accept at the end.
There is an essential difference between natural laws and the laws governing social and historical developments. Former have to be respected while the latter can be suspended and ignored for some time. There is an archetypal scene from cartoons which relies for its comical effect precisely on the confusion of these two concepts: A coyote walks floating in the air above the precipice, and it falls only after it looks down and becomes aware of how it has no support beneath its feet – as if it has momentarily forgotten the natural laws its body has to obey, and has to be reminded of them. This is humor in its purest – it plays upon contingencies of the existing conventions and forms. In the cartoon, the roles of natural and social laws are interchanged. Natural laws are temporarily suspended: Gravity is initially ignored and the coyote falls only when looking down. The inevitability of the law of gravity is faced only when the subject realizes it. Ideological interpretation: Looking down is a mistake — the system works only if no one opens his eyes.
In many ways the developments of the last six weeks have been following the coyote-roadrunner script. Two things have acted as a reality check. After years of playing the role of a market stabilizer and developing an elaborate dialogue channel with the markets, the Fed has taken charge of its traditional script, appearing to be somewhat less concerned about the feedback from the markets and focusing on the economic fundamentals. After the failure of the health care reform, and in the face of further political bottlenecks ahead, it has become clear that the fiscal inertia cannot be ignored. The optimistic outlook, based initially on the expectation of a swift fiscal stimulus and slow monetary policy, is now “levitating over the precipice” with everyone gradually “opening their eyes”.
The realization of the anticipated legislative package, essential for sustaining the “Trump trade”, is becoming increasingly more problematic. In the next six months, we will have to wait for another shot at the healthcare reform before we begin addressing the tax reform. However, given the political bottlenecks the former has been facing, the latter has become highly contentious. The “Trump trade”, it is becoming apparent, is living on borrowed time. Although the risk-on could continue in the short run, it could do so with much less intensity, possibly fizzling out in the long run.