“Trade-Offs”: The UK Sends A Subtle Warning

You have to love Richard Breslow. He’s a former FX trader and fund manager and he now writes daily commentary for Bloomberg that usually hits our inbox at around 3:30 a.m. It’s almost worth staying up for. We quote him often and today he didn’t disappoint. Here’s an excerpt:

“After the BOE and ECB meetings, the common takeaway has been they want to be in wait-and-see mode. Ready to act, but, please, give us some space. Next week we get the Fed and BOJ. The U.S. central bank will want to send a similar message. With of course, the open-minded for action pointed the other way. The BOJ has no choice. Do something bold and pray it doesn’t backfire again. For the markets, this has translated into huddling against important pivot points ready to jump, hopefully quick enough. In some ways this investor indecision is a healthy thing. Introducing at least a modicum of a sense of two-way markets.”

That last part is key. We’ve gotten used to what amounts to a one-way market. This is what we wrote on Thursday evening in commentary published elsewhere:

“It's Thursday evening and something weird just happened. Stocks closed red; as in down. Obviously that's confusing because we thought everyone was past this. We thought we had all collectively decided that stocks only go up.”

We then proceeded to document the extent to which leveraged accounts are basically making a one-way bet on central banks, getting (super) long 30Y Treasurys, US stocks, Japanese stocks, and short volatility. Apparently they’re hedging that by being long yen which, when you think about it, is an absurd contradiction, but we’ll leave that for now.

On Friday we got a glimpse of things to come in the post-Brexit UK. We could give you the details, but let’s face it, no one wants to read an in-depth breakdown of British PMI data, so we’ll just show you an annotated chart:

And here’s the color via Bloomberg:

“Money markets are pricing more aggressive easing by the BOE as the first data on the U.K. economy after the Brexit vote showed business activity shrank at the fastest since 2009.”

Yeah, so that’s bad. Here’s a look at pound implied vol:

You should pay attention to today’s PMI print out of the UK because it underscores an important point: epochal political shifts matter, and voters need to take that into consideration. It’s a kind of “be careful what you wish for,” dynamic.

The UK is something of a test case for the wave of nationalistic sentiment that’s sweeping across Europe and that GOP nominee Donald Trump doubled down on in his speech at the Republican National Convention Thursday night. We’re not here to tell you how to vote. But we are here to highlight the fact that the economic consequences of reverting to some semblance of protectionism and isolationism will be dramatic. Is that to say it’s not the right long-term policy? Well, probably. But again, we’re not going to be picking any political sides here.

It’s important to understand that this seismic shift in political sentiment is taking place against a backdrop of already lackluster global growth and trade. Any move towards protectionism will only exacerbate the trend. These are facts, not political statements. Have a look at the following rather disturbing graph:

(Chart: BofAML)

That is not good folks. It represents societal backtracking on a global scale.

For their part, BofAML says the world is already suffering from what the bank calls “stealth protectionism.” Here are a few excerpts:

“Chart 2 shows the cumulative number of foreign trade measures put in place around the world since the financial crisis hit. These data come from Global Trade Alert, a group of academics who carefully compile a detailed running list of policies that can and do impact trade flows. While this measure is comprehensive in scope — including not just tariffs and import quotas, but also a range of other policies that give preference to domestic over foreign products — it simply counts the number of measures by country. Some countries are more forthcoming than others, and these data cannot measure the severity of the policies put in place. Nonetheless, Chart 2 illustrates that the number of discriminatory policies against trade flows has accelerated recently. In addition, such restrictions have grown much more rapidly than the number of liberalizing policies. These two observations have not been widely appreciated. Data from other international organizations reveal a similar pattern.”

(Charts: BofAML)

Yikes. Now let’s just be clear: globalization has unquestionably affected the beleaguered US manufacturing complex and no one - repeat no one - likes to see people lose their livelihood. The US economy has become something of a Starbucks barista creation machine rather than an engine that creates breadwinner jobs. To the extent any politician can turn that around, it’s a good thing.

That said, deglobalization driven by a groundswell of support for nationalistic political movements in the US and Europe is something that needs to be carefully scrutinized because in the final analysis, we might not like the “trade-offs.”