DECREASING CIRCLE? The sharp swing in market sentiment on the global interest rate cycle since mid-June, above all in the G7 and Eurozone, has been a truly remarkable spectacle.

The continued escalation of US China trade tensions and the threat of a further, perhaps very sharp deterioration in the global economic outlook has played a major role in this shift. But there seem to be a number of questions and issues that very few investors and market participants really wish to address, perhaps because there might be the risk of reaching the conclusion that this is another episode of the ‘Emperor’s New Clothes’.

There is a reasonably well rehearsed rationale for not adopting a broader perspective on it, namely that the US Federal Reserve and other major central banks need to take insurance, i.e. cut rates and where applicable deploy other ‘unconventional’ measures to ensure that the palpable threat to the global economic outlook does not metastasize into stress, or even worse another full blown crisis in the financial system. The lesson of the Global Financial Crisis was that what might appear to be relatively modest stress signals in markets or the wider financial system can escalate rapidly and exponentially, and that there is no room for complacency. In principle, leaving aside any issues about ‘moral hazard’, the rationale is very logical, particularly when looking back at both 1995 and 1998, and the relatively benign outcomes for the global economy at the time from such an ‘insurance’ approach.

However the lessons of history are that the broader context of a particular policy action, or event have to be borne in mind. One of the great faults in empirical psychology (and I am a psychology graduate) is that in its efforts to ensure sound methodology, and to control for ‘other’ influences, when investigating a phenomenon or behaviour, real life context (e.g. distractions) is excluded, and makes any broader theoretical extrapolations tenuous, if not redundant. This reads across to history in a similar way. This is in the sense that all too often, a narrow perspective explanation of an event or events is sought, all too often to suit a dominant political narrative, which may be altered at a later stage, if that narrative is no longer ‘convenient’ or ‘expedient’.

The only valid part of the comparison with 1995 and 1998 is the pre- emptive nature of the Fed’s rate cut. But otherwise the world finds itself in a completely different place, except perhaps for the German economy finding itself in a dark place, at that time labouring under the burden of reunification costs, much to the schadenfreude-like glee of many other EU countries, and the USA. In 1995 and 1998, the rewards of the post ‘cold war’ peace dividend were being reaped, with the US and indeed the UK running a budget surplus, and the technology and accompanying globalization trade boom just starting, even if this along with financial deregulation was to sow the seeds of future crises. Total global FX reserves were less than $2.0 Trln, G7 interest rates mostly in a 4 to 7 % range, QE was a footnote in economic history books, and after years of tough negotiations major countries were signing up to the new WTO global trade rules.

4 | ADMISI - The Ghost In The Machine | July/August 2019

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