Where are the Equinoxal Gales? They are coming…

Blain’s Morning Porridge – September 24^th 2021 – Where are the Equinoxal Gales? They are coming…

“A wise man is one who feels the storm a’coming before the whispy clouds appear on high.”

This morning: Stock markets look to have shrugged off this week’s dip despite the likelihood of rising interest rates and the end of QE programmes – the dreaded “Taper” – next year. Markets look calm, but the equinoxal gales are coming as traders focus increasingly on the inflation vs stagflation outlook. There is increasing uncertainty on everything from China, German Elections, to Supply Chains.

And why the UK’s Green Gilt will likely increase the UK’s total funding costs.

Apologies for lack of Porridge yesterday, but I was up in London! Back in the office, shaking hands with colleagues/friends, arguing face-to-face, and then a proper client lunch.. Marvellous… I must do it more often.

Normally the autumnal equinox (which occurred yesterday) is a time of storm and gales… but the sun is shining. Is the weather lulling into a false sense of security? The big themes are changing. It’s not inflationary risk anymore. It increasingly feels like a binary outlook between inflation or stagflation. On the surface… markets are handling the news calmly:

• The Fed is going to taper – the dot-plot of governor guesses says rates rise next year. Bond markets are down.
• The Stock market has shrugged off the tensions in China and is rising.
• Both stocks and bonds are telling us the same thing – stronger economy and rising rates.. which looks like a sell bonds and buy stocks kind of day…

But.. Global supply chains look ever more fractured. Every day something else comes to light. The lack of a thingymabob here means a whatdjamacallit there isn’t available to complete a widget back there. It feels like the wheels of global industry are grinding ever slower. We’ve not only got empty meat and vegetable counters, but apparently a petrol shortage is imminent. They say the complete breakdown of society is only three toilet rolls away…

UK consumer confidence has crashed – tax-rises, the cost of everthing going up, (my single train ticket from London back to Southampton has risen 23% since March last year – and that’s not made the headlines!), and inflationary fears are soaring as folk worry about job security.

And Evergrande? It never paid its international bond coupons yesterday. It has a one-day grace period to make good. It will be in default on Monday. That might be an interesting moment..

It’s Friday… no point in worrying about things we’re only going to have to worry about all over again on Monday…. So relax.. and stock up the bunker…. The whispy “grey mares’ tails” referred to in this morning’s quote are a sign the weather is about to change…

Green Gilts Part 2

The most dicey moment I faced yesterday was receiving a lecture from a very senior investment banker about Wednesday’s MP: “The UK’s Green Gilt is Marketing Puff and a Pointless Distraction.” This chap, who I’ve known since the 1990s, told me it’s the evolution of ESG and Green Bonds that’s been the “single most important factors rising awareness, driving activism and focusing the attention of investment desks towards a decarbonised economy”. I don’t disagree or think that’s a bad thing.. but it’s becoming pure marketing hype…

He jumped in and explained to me, in pointed, short, staccato sentences:

Green bonds are the future.

Green bonds will make up the bulk of the fixed income market.

Green bonds are cheaper to issue. There is no alternative.

Really?

Arguing with him was about as pointless as a multi-faith discussion with the Spanish Inquisition. I tried to point out there is nothing a normal bond can’t already fund. Green bonds are just puff.. Nonsense, he said. He believes.. and that’s unusual in any financiers of my generation. Most of us has learnt there are many sides to any story.

Let’s not pretend there is not a problem. The ECB was on the wires warning that “ignoring climate change may decimate Europe’s economy”. According to its first climate change stress tests GDP could tumble 10%, and Europe’s banks are heavily exposed to corporates exposed to climate change risks.. Climate change is potentially the greatest challenge ever to mankind. I also accept the environment is in crisis. I’ve got kids, nephews, nieces and god-kids I want to see enjoy the planet.

I just happen to know enough about investment banking to know that trusting bankers to solve the crisis is…… insanely misguided. We get paid to sell product!

Over the years I’ve talked about green issues with many investment desk clients. The consensus (on a limited number of calls since its launch), on this week’s Green Gilt is mixed. Younger fund managers generally support it on the basis Green funding is successfully changing the investment agenda.

A number of, shall we say, more cynical, older bond managers reckon Green bonds are great for their “dirty bond” portfolio prospects: While the UK treasury will be hi-fiving themselves on the success of the Green Gilt, which has saved the country 2.5 basis points – the “greenium” – on its £15 bln Green Gilt programme, the reality is it will likely push up the yields on normal “Dirty” Gilts. In future Dirty Bonds will be discounted to Green Bonds. The UK will likely pay relatively more it £235 bln Dirty Gilt funding this year.

In other words, Rishi Sunak may just have increased the UK’s bond interest bill by around £300 mm per annum by issuing Green Gilts.

It’s all angels on the head of a pin stuff… but worth bearing in mind…

Most investors accept there are significant risks if the efficiency of the financial markets to allocate capital across the economy is impaired by a green “over-reaction”. They are also very aware and suspicious of greenwashing. They are concerned about the enforceability of Green finance agreements if bad actors sieze opportunities to arbitrage and free-ride the decarbonisation efforts of others.

There is some excellent work being done to balance green goals and economic imperatives – to come up with equations and algos that optimise green damage and economic outcomes to give green adjusted returns. I’m absolutely convinced the way forward will involve polluter pays taxes, and carbon credits. The ultimate success of a global carbon credit market will come when a carbon credit is worth zero! That really will mean we’ve sorted the problem!

In the meantime – no matter how earnestly Green Bankers believe the world will be improved by stopping mining, gas, or oil investments – it will take time, decades, to rebuild for decarbonisation – and, at the risk of repeating myself, we’re going to need to take non-intuitive decisions, like investing in gas and oil to get us through. Without mining to produce commodities, the global economy stops.

Five Things To Read Today:

BBerg – The Return of Empty Shelves and Panic Buying

WSJ – Investors Bet Environmental Fears Will Crunch Commodity Supply, Lifting Prices

Torygraph – Interest rates set to rise as soon as February amid inflation surge

FT – Investors on watch for “political shift” after Germany’s election

FT – Evergrande fallout could be worse than Lehman for China, warns Jim Chanos

Out of time, back to the day job, and have a great weekend..

Bill Blain

Strategist – Shard Capital