By Benjamin Picton, Senior Macro Strategist at Rabobank
Spain went to the polls over the weekend following a decision by Prime Minister Pedro Sanchez to seek a renewed mandate after poor municipal election results in May. The conservative opposition People’s Party was widely expected to form government with the support of the right-wing Vox party and perhaps a constellation of minor parties. However, despite the PP winning the largest number of seats, Sanchez’s ruling Socialists exceeded expectations and managed to add two more seats to their own tally. This was enough to ensure that there is no easy path to the required 176 for any coalition of the right or left. So, having resolved nothing, Spain now enters a political purgatory of sorts as the main parties attempt to convince smaller separatist parties to support their attempts to form a government.
Speaking of resolving nothing, the Wall Street Journal this morning carries two stories that give an insight into the challenge facing the Fed’s FOMC. ‘Barbenheimer’, the portmanteau for the Barbie and Oppenheimer films, has propelled the US box office to its fourth-best weekend on record. Opening weekend ticket sales reached $155 million for Barbie and $81 million for Oppenheimer. Meanwhile, Taylor Swift continues to confound attempts at monetary tightening with her Eras tour reportedly on track to become the highest-grossing concert in history, with over $1 billion worth of ticket sales. The Swift multiplier also carries benefits for hotels, airlines and hospitality venues as fans flock from around the world to attend concerts. None of this really paints a picture of a consumer economy that is on its knees, but cod psychology perhaps suggests that people are seeking escapism after years of lockdowns, pestilence and war. Another explanation that has been proffered to me in recent times is that millennials and Gen Z’s in developed countries can’t afford to buy a home no matter how much they save, so why not embrace nihilism and buy those Taylor Swift tickets? That explanation suggests that high asset prices may actually reduce the effectiveness of monetary policy transmission, which is counter to the usual logic.
So, maybe there are no clear answers to the challenges we face. Despite the proliferation of impressive quantitative models in economics departments over the last 60 years or so, economics remains more art than science. ‘Mathiness’ has given the illusion of hard scientific method, but we are all operating off an imperfect understanding of how the world works and simplifying via assumptions, like the assumption that we are all rational, utility-maximizing economic actors. Taking the time to calculate Lagrangian multipliers to solve constrained-optimization problems is all well and good, but what is the point if our set of basic assumptions do not hold in the real world? This suggests that economists have more in common with augurs than they do with physicists. I can’t help but think of this every time a journalist asks me when central bank x will deliver the first rate cut. What if that’s the wrong question?
Charting the yield on the 10-year US Treasury shows us a neat downward trend that existed between 1987 and 2022. This is part of the 40-year bull market in bonds that followed the ‘Volcker Shock’ of the early 1980s, when the last major inflationary episode was ultimately tamed by interest rates that look positively medieval by modern standards. This trend is now broken, and bond yields are moving higher. Bill Gross was quoted by Bloomberg last week saying that “a bull market is not on the cards”. To illustrate his point, Bill pointed to the rivers of new issuance, Fed balance sheet reduction and the average long-term premium of 140bps that the 10-year yield generally holds over the Fed Funds rate. Gross’ prediction contrasts to the consensus view of the Bloomberg survey, which sees 10-year yields declining steadily out to 2025.
The word “consensus” might be uncharitably substituted with “groupthink”. In a Bloomberg podcast appearance last week, former Bank of England Governor Mervyn King said that it was groupthink that drove central bank policy action in the early days of the pandemic. King points out that many senior central bankers are drawn from a small set of famous universities, where they are taught the same new-Keynesian view of how the world works. Why did it make sense to dramatically expand the money supply while the supply side of the economy was severely throttled? Because the models said any resultant inflation would be transitory. Thanks for clearing that up, Mervyn.
