I‘ve made the bearish vol point several times in the last couple of months, but I fear it’s going to fall even further than I anticipated. Now that Brexit has been delayed, what’s going to trigger excitement in G10 FX any time soon? There’s no obvious option unless you believe trade wars will escalate significantly.
That’s from Bloomberg’s Mark Cudmore and if you read the rest of the short post from which it’s excerpted, you’ll find references to the Fed minutes, the ECB and lackluster (but not wholly bad) global growth.
We kicked Wednesday off with a similar (albeit much less concise and thereby far more long-winded) post of our own, the overall thrust of which was that with Brexit set to be delayed and with central banks now back in vol.-suppression mode (as forward guidance will once again work its “magic”), cross-asset volatility could well grind lower. Here’s an excerpt from “Blocked Exits“:
In any case, all of the above is arguably conducive to an ongoing morass as political entropy perpetuates a “noisy status quo” where the decibel level of the cacophony and the sheer number of headlines around politicians’ various trials and tribulations render markets numb and otherwise desensitized. Meanwhile, a sluggish global economy and still-subdued inflation virtually guarantees dovish forward guidance from DM policymakers, a veritable vol. killer.
Well, the ECB meeting and the March Fed minutes did indeed underscore the notion that rates will remain on hold for the foreseeable future and, later in the evening, Brexit was delayed until Halloween (which seems appropriate).
Regular readers know how I feel about Brexit – originally, I thought it was a potentially historic disaster, but nearly three years on from the referendum, it now seems more “silly debacle” than “catastrophe”. Admittedly (and I’ve said this dozens of times) my take on Brexit is informed (my critics on this subject would say “misinformed”) by a generalized disdain for the semi-global populist uprising that gave birth to it. I have very good reasons to believe that 2015 and 2016 were years during which western democracies were under siege by a veritable symphony of propaganda that helped sow division and hate and otherwise preyed on the legitimate grievances of the middle class and undereducated. Long story short: I was never going to be a fan of Brexit because it was, in a part, a manifestation of something I firmly believe is poisonous.
That’s a 30,000-foot view rooted mostly in political theory. Obviously, I do not live in the UK and I would never pretend to understand all of the nuances. One person who does have a read on the nuance is SocGen’s Albert Edwards, who on Thursday reminds you that he voted “Leave”. But that doesn’t mean he won’t be your friend if you’re not similarly inclined. “I can talk at length on the topic as one client in Atlanta found out when they asked my views, but I have certainly never fallen out with anyone discussing the topic, nor do I intend to”, he writes in his latest note, after saying that really, he’d rather “not say anything on this topic as it evokes strong feelings and being the sensitive soul that I am, I don’t want to be on the receiving end of a torrent of abuse.”
But opine Albert must, because Wednesday’s delay is hard to ignore. He goes on to tell a story about how, in February, he did something he “hadn’t done for about 30 years” – he attended a lecture held by a central bank rep.
Why would Albert do such a thing? I’ll let him tell you. To wit:
I wanted to hear Bank of England MPC member Gertjan Vlieghe speak and to ask him if he really said that “unwinding QE need not have a material impact on the shape of the yield curve, or indeed on the economy, if properly communicated and done gradually”! What?! Surely he must have been misunderstood or misquoted? But as events would have it, Vlieghe’s comments on Brexit then shocked me, and despite sticking up my hand at the end to confront him on the veracity of his analysis, the chair instead chose to take questions from well-known journalists sitting in the front row as opposed to me someone they had never seen before muttering to himself and with a shaggy beard and wearing an anorak sitting in the back row. OK I can understand that!
Ok, so what “shocked” Albert about Vlieghe’s Brexit comments was that he apparently cited familiar numbers showing the UK has lost roughly 2% of its GDP output, amounting to about £800m a week since the referendum.
“Vlieghe in his talk delighted in juxtaposing the lost £800m per week to the poster on the side of the Leave battle bus that claimed that the UK would save £350m per week”, Edwards recounts, before calling it a “doppelganger methodology” which has been “used by other commentators like the Centre for European Reform and the S&P ratings agency to arrive at similar conclusions.”
Here is the full quote from Vlieghe’s speech:
Consider the following thought experiment: What if nothing unusual had happened in the UK domestically and UK growth had been in line with its close historical relationship to the rest of the world? Figure 10 (see chart) quantifies this thought experiment with what is known as a “synthetic” UK economy without Brexit. What is shown here is how much weaker the economy has been relative to what we might have expected, given the global growth data. The different lines in Figure 11 show estimates using different country groups, just to show that the result is robust to which countries are used to proxy “the rest of the world”. The analysis suggests that since the vote in June 2016, we have lost 2% of GDP relative to a scenario where there had been no significant domestic economic events. That amounts to around 40 billion pounds per year, or 800 million per week of lost income for the country as a whole.
To be clear, Albert is a guy who will find holes to poke in even the most trenchant of economic analysis, so presenting him with something like that (which isn’t very trenchant – not even on its face) is just asking for trouble.
Albert takes issue with with what he considers to be a gross omission. Specifically, he notes that “this methodology omits the fact that there has been massive fiscal retrenchment since the June 2016 Referendum.” Here, in brief, is Albert’s argument:
The OECD, and others, show that the UK’s cyclically adjusted, primary fiscal deficit (ie excluding interest payments) declined by around 1¼% in each of fiscal year 2016 and 2017 (see left-hand chart below). This unusually large contractionary impulse to the UK economy stands in stark contrast to that of the eurozone and the US over the same period. The doppelganger methodology ignores this huge UK domestic shock. I believe the UK’s extraordinary fiscal austerity since just before the June 2016 Referendum wholly accounts for the missing 2% of UK GDP. The doppelganger method solely models UK growth in relation to overseas growth, so cannot identify this domestic fiscal shock and hence incorrectly attributes it to Brexit.
That sounds like a pretty compelling counter-argument, even if Albert’s subsequent suggestion that the negative effect on business investment from Brexit uncertainty is somehow mitigated by a “flipside” of faster hiring (“…as this can be reversed more easily if need be in the event of say, a Hard Brexit”) is a bit less convincing, at least to the extent that people presumably don’t want to think about their brand new jobs as being dependent on what variant of Brexit is ultimately agreed.
On the fiscal retrenchment point, Albert admits that he doesn’t know why more people aren’t talking about it.
“So why do all these learned commentators use the ‘doppelganger’ model to erroneously conclude that the UK has lost 2-2½% of GDP (or £800m+ per week) since the Brexit Referendum?”, he asks, before posing two additional queries. “Why do they totally ignore the hugely restrictive impact of the 2½% of fiscal tightening? Or am I just being very, very stupid and missing something (again)?”
If only the above-mentioned Vlieghe had taken his question, we would know the answer – or something. Here’s Albert:
The honest answer is that I simply don’t know and that is why I was jumping up and down in my seat waving my hand in the air I wanted to ask Gertjan Vlieghe that very question but was ignored.
Ultimately, Edwards writes it off to confirmation bias.
Of course none of the above means that Albert harbors a rosy view on the UK economy, because that wouldn’t exactly be on-brand, as it were. In fact, “notwithstanding” his assertion that the impact of the referendum isn’t what it’s purported to be, he says the UK economy is “a disaster waiting to fall into deep recession.” What’s the rationale for that? Well, it’s actually Brexit-related too, but the line of argument is different. Here’s Albert:
The UK household sector saving ratio collapsed in the aftermath of the June 2016 Referendum as households sought to maintain their consumption spending in the face of a severe squeeze in real incomes. Note how far the UK SR has fallen below that of the US, which it normally tracks! The June 2016 Brexit Referendum did indeed have a big impact on the UK economy, but not in the way most commentators are describing. The UK consumer is living on borrowed time (and borrowed money) and when the ratio adjusts back upwards, likely in the next recession, the economy will be laid very low indeed. But as of now the Brexit vote has had a minimal impact on the UK economy in contrast to what many would have us believe.
In any case, on a day when the Brexit delay will be grabbing headlines, the above is, at the very least, germane, and I suppose the most important takeaway may be that if you want to get called on at a speaking engagement featuring a central bank representative, don’t “mutter to yourself” while sitting in the back of the room.
Or, conversely, maybe the takeaway is that if we want good questions and not softballs from reporters at speaking events, the host should always be required to call on at least one back-row guy sporting “a shaggy beard and wearing an anorak.”