The big news in financial markets over recent days was not the the full-blown culture war raging in the US over the Brett Kavanaugh nomination, but a rather more prosaic rise in bond yields.
James Carville, a senior figure in the Clinton White House, once famously said that if there is reincarnation he wants to come back as the bond market since "I can then intimidate everybody".
Bond markets might sound like the most boring corner of the global financial landscape but they are, ultimately, the only thing that matters for investors. Everything about the economic present and future is contained in bond prices.
They don’t capture the economic headlines in the way that stock market gyrations do, but the ups and downs of bond markets are much more important than rises and falls in the Dow Jones index or any other equity market barometer. In fact, over the long haul, it is the bond market that drives those stock markets, not the other way around.
It is a weird time in those stock markets. Notwithstanding a poor week, US equities are flirting with all-time highs. This is far from the case elsewhere in the world. Emerging market stocks are in bear market territory, the FTSE 100 index of UK stocks isn’t that much above levels first seen nearly 20 years ago, European stocks are in the doldrums. Chinese shares have been sold off and Japanese stocks are still a way off levels reached in the 1980s.
Disproportionate weight
The US represents a disproportionate weight in global stock market indices. Depending on the index that we look at (there are many), the share taken up by US stocks can be as high as 60 per cent.
Different data gathered also differ on the relative importance of the US economy. On some measures, the US is only 15 per cent or so of the global economy.
At most it is 25 per cent. Anyone who looks at the US stock market as a gauge of global economic health risks a big mistake. The world is not in as good a shape as the US and even that economy may be heading for stormy waters.
US equities fell last week because bond prices also fell; the links aren’t always that immediate but, over the long haul, thats the way financial markets typically work.
Bond prices went down because the US economy is doing even better than expected. That might seem paradoxical: isn’t good news for the economy good news for stocks? Yes and no. If economic growth leads to higher profits without inflation, then stocks can usually go up without having to worry about bonds.
So, it’s that inflation worry, something that hasn’t been around for many years. Bonds are finally getting twitchy about inflation prospects. That sets up the possibility that significant rises in interest rates are ahead, at least in the US, as the authorities choke off growth to put a lid on price rises.
Even if the economy is doing well at the moment (hence recent buoyancy in the equity market), it may be heading for a fall, via higher interest rates. It’s that prospect of a slump that is now worrying stock market investors. Good economic news is in the past – and so is in the price – but what does the future hold?
Bonds and equities are constantly playing a shifting game of expectations about the future. US equities have, in part at least, been boosted by the Trump corporate tax cuts. That might turn out to be a sugar high.
More sober
The more sober bond market looks at those tax cuts and sees greatly increased government borrowing, a booming economy and the potential for higher interest rates and even a possible mistake by the Federal Reserve: interest rates may go up too much and push the economy into recession, not just a gentle slowdown.
Many financial commentators say that the conditions for a crisis are building. More US interest rate rises are in prospect, something that will hurt a lot of people far from America’s borders.
There has been a borrowing binge – often in dollars – by governments and corporates the world over. In fact, unlike the crisis of 10 years ago, there is a cacophonous chorus saying that the next one is just around the corner.
A contrarian might take some crumbs of comfort from that. “A crisis is coming” is very nearly a consensus view in some quarters.
It's not just global debt that has some analysts worried. John Authers, the chief markets commentator of the Financial Times, wrote his last piece for the newspaper during the week about the total breakdown of trust in financial markets.
Without trust, markets will cease to function; if he is right, it is a wonder that markets and economies are operating as well as they are. On an even more dystopian theme, it seems clear to some people that our civilisation is going the way of the Romans and the Greeks – the Kavanaugh hearings being just one marker of our inexorable decline.
