Playing with it

There were some heart palps on this blog yesterday as the news spread people in Denmark have free mortgages. Well, almost free. The growing plop in global interest rates has pushed home loans just below zero in that country, while bank fees have brought them back up to about one-half of one per cent. Still pretty rad. A thirty-year borrowing at less than inflation. Essentially gratis money.

(Before you reach for your passport be aware home-owning Danes are taxed extra just because they have houses – which is, the government says, unfair to renters. What a socialist utopia!)

But this isn’t about Denmark, despite its gooey pastry and Metallica roots. Instead we need to discuss the sinister side of rates.

As you know the Fed cut its key level in the US the other day. Markets think there’s a lot more to come. On Wednesday New Zealand’s bank shocked people by slashing its rate by a full half-point. Thailand cut. India cut. Australia will soon cut.

Yield curves are inverted in multiple countries. That’s when the return on a long-term bond is less than what short deposits pay. This is the result of investors (and Mr. Market) believing central banks will chop the cost of money even more in the future. Why? Because they forecast a recession.

So, weirdly, 30-year bonds give less than 90-day bills. Every recession in the last 50 years has been preceded by an inversion. But not every time yields have flipped has there been a recession. So let’s cut the drama. A slowdown is not a certainty. But as this blog has said a few times lately, one is inevitable. Given the events of the past week, it’s closer.

Trump shocked markets with his announcement of a fat new tariff on China, just after the two sides had started talking again. The Chinese refused to cave, let their currency slip and stopped buying more US stuff. Stock investors scrambled to take risk off the table. Billions has flowed into the safety of bonds, driving prices up and yields down. It could all get worse if China starts buying Iranian oil – a nightmare scenario. All Trump’s doing. Then add in Brexit, tanks headed for the streets of Hong Kong and a Yankee-Sino trade war that could beggar both economies.

So money looks for safety and central bankers start turning on the taps. Rates fall. In Canada the yield on 10-year government bonds is almost half a point below what 3-month bills pay – the biggest gap in twenty years. So the market here is also betting on cheaper money from the Bank of Canada. A global slowdown, after all, will depress oil (it’s already on the skids) which is still our No.1 export. Sucks.

One concern – even ten years after the credit crisis central banks have not been able to hike rates back to ‘normal’ levels. The ascent of Trump changed everything. At the same time he’s been fighting the Fed for rate cuts, the quixotic president has impacted the entire global economy with a return to 19th Century protectionism, tariffs and nationalism. ‘Trade wars are easy to win,’ he famously tweeted as he started this one. But financial markets print the opposite. Said former US Treasury Secretary Larry Summers this week: “You can often play with fire and not have anything untoward happen, but if you do it too much you eventually get burned.”

Some people think Trump’s a genius for creating this conflict and forcing China to reform its predatory trade practices. Besides, all this Asian-bating and wall-building suits his political base. But others see danger in deliberately fraying a global system of freer trade and rising prosperity. So now the war is not just between America and China, but between nationalists and globalists. Both can’t win.

So, stocks down and bonds up. If the standoff continues, companies may scale back on investments and growth, curbing revenues while facing higher input costs. Central banks will drop the cost of money and bring back QE – quantitative easing. Ultimately hiring cools and the North American jobs juggernaut ends. Consumer spending, which makes up 70% of the economy, slacks off. Mortgages may dip to 2%, but in a far different world than we occupied a decade ago. And what if Trump wins another four-year term in 2020?

If you have eschewed our advice and kept an all-stock portfolio, put on your helmet and Big Boy pants. You’ll need them. If you’re a saver, you may face years of negative returns as the banks pay you far less than inflation. Hope your pot of money is a big one. If you have a balanced and diversified portfolio, expect volatility but resist the temptation to tinker or bail. Losses are blunted and recovery time made short. History is on your side.

And history is bigger than Trump.