The US Exceptionalism Paradox

By Benjamin Picton, senior macro strategist at Rabobank

Winter Of Discontent

US stocks closed lower yesterday with the S&P500 down 0.3%, the DOW down 0.35% and the NASDAQ 0.25% lower. European stocks were sold even harder, with the CAC40 coming in for particular punishment to fall 1.14% on the day while China’s CSI300 was the beneficiary of the delayed stimulus bounce that we flagged yesterday to close 0.7% higher.

The Dollar rose for a third-straight day and the Treasury curve bear-steepened again with 10-year yields rising 2.5bps to 4.23% and 2-year yields up 1.9bp to 4.14%. European sovereign yields were mostly higher at the long end (with the exception of Germany), but 2-year yields were lower across the board with the biggest moves coming in France (-5.1bps) and Germany (-3.8bps).

UK Gilts were conspicuous in their underperformance. 2-year Gilt yields rose 2.9bps and 10-year yields were up 5.3bps, while the UK pound had its highest daily close against the Euro since 2016. That’s despite OIS futures actually paring-back the expected speed and depth of the ECB rate cutting cycle since the start of last week, while amping up bets on the pace of cuts in the UK over the same period.

UK Chancellor Rachel Reeves has reportedly told Ministerial colleagues to find savings amounting to 5% of the departmental budgets. The push to economise comes amid ongoing public discontent over expansion of the state in Reeves’ recent budget, and a desire by Prime Minister Keir Starmer to prioritise growth measures. The push for growth was dealt a bit of a blow yesterday by news that equipment-hire firm Ashtead is likely to become the latest in a long line of companies shifting their primary listing from the London stock exchange to New York.

The trend of all roads leading to the United States is an interesting one. The theme seems to be that capital markets are becoming more globalized just as trade is perhaps becoming less globalized. US exchanges are now dominating other national bourses in the same way that the London or Paris exchanges dominated smaller regional stock exchanges in years gone by.

Dollar strength plays a key role in the trend. Models like Brent Johnson’s Dollar Milkshake Theory suggest that the Dollar’s status as the reserve currency, along with relatively higher interest rates in the USA, is effectively sucking capital into the United States resulting in higher foreign investment, higher growth and higher equity valuations than elsewhere.

The cycle becomes self-reinforcing, but also exacerbates structural imbalances in the world economy. Policy makers in Europe and elsewhere will need to grapple with this trend as the incoming Trump administration adopts a policy stance designed to aggressively crowd investment into the United States through a combination of tax cuts, punitive/protective tariffs, deregulation and incentives like his commitment overnight to fast-track approvals for anyone investing $1 billion or more in the USA.

As the USA competes harder for its slice of the global supply of savings that is fixed in the short run, the unavoidable corollary is that there will be less savings available for investment elsewhere. MMTers would argue that other countries could solve the problem by printing and spending until their economies hit the inflation rev limiter, but in a time of real factor constraints (such as now) this solution might be of limited use because land, labor and capital is already close to fully employed, so there is a chicken and egg problem surrounding how to boost the supply side of the economy without stoking inflation that will further diminish living standards.

Compounding the problem (or perhaps resulting from it) is the increased polarization that we are now seeing in societies around the world. The rise of the far right and the far left in European politics is well documented, academic psychologists on US network TV are telling viewers to avoid family members who hold different political opinions over the holidays, the murder of a healthcare CEO in New York is being openly celebrated in online forums, and fascists and Marxists are brawling on the streets of Melbourne like it’s the 1920s.

Our Global Strategist, Michael Every, wrote about these trends in 2019’s ‘The Age of Rage’, concluding that populism is here to stay and that challenges to the liberal world order are only growing. It’s not immediately clear that political leaders have fully grasped the nettle. Joe Biden and Kamala Harris learned firsthand that a slowing in the rate of change of prices will not be celebrated (or rewarded) when the price level has permanently reset ~20% higher. Likewise, the Aussie Housing Minister this week caused a minor online sensation by telling young voters priced out of Australia’s poisonously expensive real estate market that she wanted to see prices to go up, not down.

That position makes sense under a neoliberal paradigm seeking to encourage new private investment in construction and fortify the balance sheets of banks and incumbent homeowners, but it is politically red-hot for generations already drifting to political extremes in search of a better deal, or at least the same deal that their parents had. For those discontents, Mario Draghi’s “slow agony” is already here, and the clock is ticking for moderate liberalism to find solutions that will prevent further fracturing and polarization.