Over the weekend, I wrote that outside of knee-jerk reactions to adverse headlines, durable price adjustments usually only occur when there’s a clear link between political turmoil and the factors that impact the fundamentals for a given asset class.
Further, I emphasized that the capacity for geopolitics to impact markets has been muted in the post-financial crisis world by central bank forward guidance and accommodation.
Tuesday is a case in point. Stimulus (indeed, even the prospect of stimulus) outweighs geopolitical concerns at almost every turn.
Equities surged globally, erasing the bad vibes that prevailed for most of Monday, as the release of concrete plans from the Fed to begin corporate bond buying on Tuesday and reports that the Trump administration is drawing up plans for a ~$1 trillion infrastructure plan, bolstered investor sentiment.
That, despite a serious provocation from North Korea, whose military blew up the inter-Korean liaison office. The building is on the North’s side of the border.
In a characteristically delirious statement, KCNA declared all progress between the two sides “tragically ruined with a terrific explosion”.
“The liaison office was essentially already dead, so, if there’s a real problem, then it’s for South Korean taxpayers”, one expert said.
Although the move was expected, recent rumblings out of Pyongyang suggest Kim Jong Un’s sister, Kim Yo Jong, is ascendant. During Kim’s health scare this year, some questioned the feasibility of Kim Yo Jong becoming the country’s leader in the event of her brother’s death. Those questions have been put to rest over the past three days, during which she appears to have assumed control of the military, or at least in terms of making public proclamations about what the country’s armed forces should do next and how relations between the North and South should evolve.
That is, of course, not to suggest that Kim Jong Un is not judge, jury and executioner, it’s just to say that, for now, he appears to be devolving quite a bit of power to Kim Yo Jong, who is just 30. The two are very close. North Korea has also threatened to send troops back into the DMZ. Just two years ago, Kim Yo Jong helped lead the rapprochement effort. Now, she is spearheading the push in the opposite direction.
You can make what you will of that. The destruction of the liaison office is largely meaningless, but in no sense is it “good” news.
South Korean stocks shook off the drama to surge 5% on Tuesday, but you should remember that the Kospi plunged on Monday, so the snapback (on the heels of the Fed’s announcement of new corporate bond purchases) essentially takes the benchmark back to even for the week.
The same is true for Japanese equities. The BOJ on Tuesday enhanced support for loans to companies coping with the fallout from the pandemic and the country’s recession, which will stretch into a third quarter in Q2. Kuroda said rates will remain ultra-low until at least 2023. Aside from the topped-up lending facility, the bank kept policy unchanged, as expected.
The big stimulus news came from the US, where the Trump administration is cobbling together what’s being described as a “preliminary draft” of an infrastructure proposal worth $1 trillion. The Department of Transportation is taking the lead. The plan calls for work on roads and bridges, but also earmarks funding for 5G wireless infrastructure and rural broadband.
While championed by both parties at various intervals, large-scale infrastructure spending remains elusive. That could change in the post-COVID environment as both Democrats and Republicans look for ways to stimulate the economy and get Americans back to work.
Most analysts expect another $1 trillion in virus relief spending, a figure Mitch McConnell is apparently comfortable with. That falls well short of Democrats’ HEROEs Act, but it’s possible that Republicans could get behind some combination of a smaller virus relief package that includes Democratic priorities, while bridging the gap (pardon the infrastructure pun) with a White House-sponsored infrastructure push that could be pitched as something other than “handouts”.
“Since he took office, President Trump has been serious about a bipartisan infrastructure package that rebuilds our crumbling roads and bridges, invests in future industries, and promotes permitting efficiency”, White House spokesman Judd Deere remarked, in a statement.
“Hopes for federal legislation [on infrastructure investment] ended in May 2019 after Democrats said Trump walked out of a meeting on a $2 trillion plan and vowed not to work with them unless they stopped investigating him and his administration”, Bloomberg dryly notes, adding that “the Democratic bill to reauthorize the current infrastructure program was unveiled this month [and] includes investments in roads and bridges, funding to make certain projects more resilient to climate change, and funding for public transit and Amtrak, among other priorities”.
As ever, there are spurious questions about “how to pay for the measures”, as though the US can’t just borrow or, better yet, simply conjure the necessary digital money out of thin air, as the country is perfectly capable of doing. Some Republicans are starting to worry about the deficit again, and a fourth virus relief bill would likely push the red ink beyond 20% of GDP this year.
San Francisco Fed boss Mary Daly understands that this isn’t the time to be concerned about borrowing and spending, especially not if the money is for a good cause.
“Now is an especially good time to take on this type of debt”, she said, in a speech on Monday. “Even before the crisis, we were in an environment of low interest rates – and that is expected to continue for the foreseeable future. This makes public spending relatively cheap and easy to finance”.
She should know. Trump (the self-declared “king of debt”) is fully apprised of this, and you can expect him to push the infrastructure idea forward. Remember, whoever wins the White House needs to spend into the reopened economy if there’s any hope of engineering the type of robust recovery that everyone claims they want to see. The same is true across the pond in Europe.
“Our current base case is that the US will pass a further $1 trillion stimulus package between now and July and that the European Union will agree on a €750 billion recovery fund very similar to the current French-German proposal”, Morgan Stanley said, in their semi-annual outlook released Sunday.
Remember, central banks are accommodating debt issued to fund stimulus. We are closer than ever to overt monetary financing. So, even if you want to claim that this is inflationary madness, it makes no sense to talk about how it will be funded. Poignantly, this is how it will be funded:
“The failure or dilution of either and, more broadly, a premature shift back towards belt-tightening would be a major risk”, the bank added, noting that “misguided focus on debt/GDP ratios and a premature shift to fiscal austerity was a major driver of why the post-GFC recovery was so weak”.
Between the Fed’s push further into the corporate bond market, renewed speculation around an infrastructure push from the Trump administration, and the incremental additional easing and nod to “lower forever” from Japan, there was more than enough stimulus chatter in the market to override concerns about the demolition of an abandoned liaison office in North Korea.
A potentially more worrisome development on the geopolitical front is the death of three Indian soldiers in border clashes with Chinese troops.
But, again, stimulus > geopolitics when it comes to markets. The equation is just that simple. Until it’s not. It’s all fun and
games gains, until someone starts waving the nukes around.