The late British Prime Minister Harold Wilson will forever be remembered for his line “A week is a long time in politics”. In markets, a week is an aeon. Sometimes a day is a long time, sometimes even an hour. And in the age of Trump, that wisdom – if it is indeed a wisdom rather than merely a pragmatic observation – carries more weight than ever.
The past week, a goodly part of which I spent sitting on the River Tay in Scotland hoping in vain to hook a salmon which I’d have been obliged by law to put straight back into the water even if I had done, had been touted as being unusually important for determining the trajectory of markets through the end of 2025. And, although it did in the end prove to be one of great surprises, it would be a brave investor who would take what was revealed, position the books and declare “Alea iacta est”, the die is cast.
The Federal Reserve had surely done what had been expected by not cutting US interest rates and all was good. But then Friday not only pulled down the flag but then cut off the flagpole at the base. The July jobs report at the flash of a screen looks to have reset America’s economic narrative and by all accounts not in the way President Trump would have wanted.
The key headline number for jobs created was a disappointing 73,000 which was below the 110,000 consensus expectation but it was the downward revision of the May and June figures by an aggregate of 258,000 that set off the alarms. US bond markets went into overdrive and, although it will be the decline in the Dow Jones by 1.23%, the S&P500 by 1.60% and the Nasdaq by 2.24% that will make most of the headlines, it is the collapse in yields across the curve that tells the best story.
The yield on the benchmark 10 year note had immediately before the Bureau of Labor Statistics released its findings been marked at 4.41%. By the close of business, that had collapsed to 4.21%. Meanwhile, the 2 year note, the canary in the interest rate coal mine had fallen even further to close at 3.68%, 26 bps lower on the day. Moves like these are rare which indicate a market in shock. The argument that the US economy and its employment situation were weathering without notable impact the first six months of the Trump presidency with its relentless attack on the global trade edifice had, so it appears, just been holed below the waterline.
There seems little doubt that the members of the Federal Reserve’s monetary policy committee, the FOMC, had no prior knowledge of what was in store – they opted not to ease policy by cutting rates on Wednesday – on Friday afternoon markets did it for them. Fed Chairman Jay Powell and his committee clearly put gently rising inflation ahead of all other considerations although now with a new light being shone on labour market developments the future interest rate trajectory seems to be set.
The President who has been demanding lower rates – and we’re not talking the odd quarter point here and there – went apoplectic and in short order shot the messenger by summarily firing Erika McEntarfer, the Commissioner of the BLS. Ms McEntarfer had been appointed by President Biden so Trump announced that the figures were “phoney”, that they had been manipulated for political reasons and that it was all a conspiracy against him. Markets were and are appalled by her firing and above all by the accusation that the BLS, or any of the other federal statistical agencies for that matter, might be political and that by firing its head it now seriously risks becoming just that. On the follow McEntarfer’s predecessor William Beach, himself a Trump 1.0 appointee, called her removal from office “damaging”.
Whoever thought they might have just about got the measure of the emotionally volatile President will surely have to admit that they must have spoken too soon as in a second unexpected act he declared trade negotiations with Switzerland to have been a failure and imposed an eyewatering flat tariff rate of 39% on Swiss exports to the USA. The Swiss are speechless as their negotiators thought they had a deal ready for signing and Switzerland’s President – it’s an annually rotating privilege – Karin Keller-Sutter is left wearing the emperor’s new suit of clothes.
In her shell-shocked home she stands accused of misreading the runes although who was to know that, despite apparently having the buy in from Treasury Secretary Scott Bessent and from Trade Representative Jameson Greer, their boss was going to so demonstratively throw his toys out of the pram. Somewhat remarkably, however, the Swiss franc did not notably weaken against the US dollar and although trading at above 80 centimes/dollar remains at the stronger end of its more recent range. If the Donald had preferred skiing to golf the outcome might have been different.
Well, never a boring moment.
Meanwhile, I have been more than just mildly annoyed by much of what I have been reading in the established press as swathes of journalists are already busily seeking the guilty parties for the next financial crisis. My suspicion of private equity and debt are no secret and The Spectator which I generally read with pleasure last week headlined with a sweeping kick at private markets. I read the long article and decided that it, like so many analyses of risk, somehow missed the point. I had during the first years of the century found myself on the structured credit desk of Bank of America and as we all know the Global Financial Crisis was made by greedy bankers of whom by definition I would have had to have been one. There is, however, an angle which is always overlooked and that is that no matter what bankers might have created there would have had to have been people prepared to buy it. And let us not forget that the investors, the ones who so loudly cried “Foul!” when it all went to hell in a handcart had the same quantitative degrees, the same MBAs and the same CFAs as the bankers with whom they were doing business. They were in essence all part of the same value chain.
There was much handwringing back in 2007 and 2008 about the unemployed, unmarried mothers who took out mortgages in order to buy their mobile home and who sat at the base of the subprime mortgage crisis. ”How could they be so stupid?”, “How could they not know that they would never be able to afford the mortgage?”, “Didn’t they see that the teaser rate would not last?”. I have always wondered why it was only the investment bankers who did the repackaging who were given stick and not the local mortgage brokers who filled in the application forms for the potential mortgagees and who fed the beast or the investment managers who of their own volition bought hundreds of billions of the stuff. Yes, they too were part of the value chain. The borrowers who should not have borrowed, however, were in my book in many respects innocent. If you put a box of chocolates in front of a four year old who proceeds to eat them all, do you blame the child when it is subsequently violently sick all over the beige sofa? And trust me, there were at the time near-illiterate mortgage borrowers whose intellect did not by far exceed that of said four year old.
The current market is of course not the same. It is in fact the 180 degree opposite. This time, it is not the innocent punter who is the borrower facing highly qualified lenders – the bankers are still in the intermediary role – but within the private markets it is the borrowers who are the ones with the CFAs, the MBAs and the PhDs and it is the punters, the retail investors, who have been bamboozled into providing the capital to fund the value chain.
Peters’ First Law which emerged in the early days of the GFC holds that credit risk is like energy; it can be converted but it cannot be destroyed. It doesn’t matter how one repackages the risk, how many hedges are applied or how the portfolio is sliced and diced, if at any time or anywhere there is a default someone will lose their money. More to the point, the more highly structured the investment vehicle, the more mouths will have had to be fed along the way and the greater the loss or lower the recovery rate for the poor sod at the end of the chain.
Funnily enough it was not the actual defaults that launched the GFC but it was the sudden discovery that, if defaults were to occur, the lenders to structured finance products – from residential mortgage-backed securities to repackaged auto loans – no longer knew to whom they were actually lending. They were lending to a statistic. I well remember a meeting I had at the Bank of England where there was great excitement over securitisation. It meant, so said the folks at the Old Lady, that risks would be far more evenly distributed across the financial system. Regulatory authorities had always been fearful of risk concentration and on how much one lender was exposed to one borrower. Selling bits of whole portfolios of loans to multiple lenders spread the exposure and so it was argued reduced concentration risk. Bingo! As such not wrong although when in late 2007 things began to get hairy and lenders tried to assess how much they had lent to whom they discovered that they no longer knew. They panicked. This was where the first landmine went off and the rest, as the saying goes, is history.
A market is where buyers and sellers meet and if there are only sellers and no buyers there is no market. That happened variably throughout 2007 and 2008 when perfectly good investments could barely be given away. The epic 2019 collapse of Woodford Investment Management was living proof of what happens when lesser liquid assets find themselves being forcibly sold into a market that sees them coming. The same risks that downed Neil Woodford lurk everywhere and although private funds quite clearly warn potential investors of underlying liquidity risk it is not until the crisis hits that it becomes clear that this is not a phenomenon that builds up gradually but that it will in all likelihood go from nought to a hundred with no stops in between.
On my drive north, I stopped off in Penrith in Cumbria – for geographically challenged readers that is on the map just a few inches south of the Scottish border – where I met up and took tea with my commodities guru. Two old troopers swapping war stories? Nearly but not quite. We are both aware that in market terms we are superannuated and that the current crop of movers and shakers do not have the experience of the long market depression of the 1970s and ‘80s, of the Crash of ’87, of the dot.com bust of 2001 and even at the point of the GFC, now going on two decades ago, they were in many cases still graduate trainees or junior jubs. This does not make them bad people or us good ones. What it does mean, however, is that although they can read all the books in the world about how these crises played out, they will never be able to study in theory the experience of smelling and tasting the gradual and inexorable build-up of risk. They will all be carefully studying the horizon without having found themselves as we did under attack from an entirely unexpected direction.
Please don’t get me wrong. Neither of us or any other old codger for that matter would claim to be able to accurately predict when and where the brown stuff will hit the propellor or what might be the catalyst that will trigger the seismic event but we do have the experience to have developed a pretty good idea of where the greatest amount of damage will be done if, as and when.
So off we trot into a new week and how do I wish that for once we won’t have eight out of ten headlines containing the word “Trump”. I was seriously worried when I read that the 200 Civil Service internships are in future to be handed exclusively to students of provable working class backgrounds. Those with memory of the German Democratic Republic, that paragon of liberal democracy, will no doubt recall that it decreed that only children of working class parents could go to university. In other words, even if the youngster had an IQ of 140 and was what the Americans call a “straight-A stoodent”, if the parents were university graduates, there was no academic future for the child. I am not trying to imply that young people of working class backgrounds should be any less competent and that on merit they must be given an even chance but I remain a fervent opponent of all forms of social engineering. Look where it got the GDR. By the way, how small does your parents’ farm need to be for you to rate as working class or are youngsters of a farming background entirely excluded? Are they about to be treated as the kulaks were by the Bolsheviks? Unfashionable thought as it might be, could it not be argued that many of this country’s current problems result not from too much but too little good old cold meritocracy?
More on the Bank of England’s rate decision due Thursday to follow although it looks as though, despite being faced with above target inflation, a quarter point cut in bank rate is to be expected.
