How can anyone make sense of today’s markets? That is a question many investors might ask. And at last week’s International Monetary Fund meetings in Washington plenty of macroeconomic ideas were being tossed around.
But for my money, one of the smartest answers came not from any finance minister or any IMF report but at a presentation privately offered on the sidelines of the IMF meetings by Axel Weber, former head of the Bundesbank, now chairman of UBS.
Mr Weber argues that several issues are shaping markets today. And it is worth repeating this list since, if Mr Weber is correct (as I think he is), it provides a useful framework to understand events such as this week’s wild swings in sterling.
So what is on Mr Weber’s list? The first point is a cheerful one: the banking system today is much stronger than a decade ago as a result of post-crisis reforms. A cynic might argue that Mr Weber is arguing his own book. And not even he would deny that problems remain in the system, particularly in Europe: Deutsche Bank is grappling with a threatened $14bn US regulatory fine, Italian banks (among others) remain plagued with bad loans and almost all institutions are struggling to find a viable business model. No wonder that Tidjane Thiam, Mr Weber’s counterpart at Credit Suisse, has dubbed Europe’s banks “ not really investible”.
But leaving aside those (big) caveats, the fact is that western banks now have far more spare liquidity and capital. “If you look at pre-crisis, you could run a global bank on 1 or 2 per cent of core tier one capital,” Mr Weber told Fox TV in Washington. “Now most of the banks are well above 10 per cent.”
That reduces the chance of banks toppling over amid a macroeconomic shock; indeed, these higher capital and liquidity ratios have already blunted some of the panic around the recent Deutsche Bank woes.
However, the second point on Mr Weber’s list is not cheering: he believes that, while the banking system looks healthier, markets do not. The issue that investors need to understand now is that many “markets” are not true, free markets because of heavy government intervention.
To my mind, this point needs to be proclaimed with a megaphone. It is evident in government bond markets, where the central banks of Japan, US and eurozone currently hold a third, a fifth and a tenth of the outstanding local government bonds.
Central bank purchases are distorting the price of European corporate bonds and Japanese equities, with knock-on effects in numerous other asset classes. “I don’t think a single trader can tell you what the appropriate price of an asset he buys is, if you take out all this central bank intervention,” Mr Weber warned.
That leads to the third point: these distorted markets are increasingly hostage to unfathomable political risk. A decade ago, investors thought (or hoped) they could price western assets by analysing underlying economic values with spreadsheets; political risk was only something that emerging market investors worried about.
Now investors holding US, Japanese or European assets need to ponder questions such as: how much further can central banks take quantitative easing? Are the US and UK governments becoming anti-business? Does the rise of Donald Trump, as well as the Britain’s vote to leave the EU, herald new protectionism?
Most investors are not well equipped for an analysis of this kind. They built their careers by crunching numbers, not pondering social science. They now face an unpredictable and unfathomable world.
To put it another way, the real danger in finance is the not one that tends to be discussed: that banks will implode (as they did in 2008). It is, rather, the threat that investors and investment groups will be wiped out by wild price swings from an unexpected political shock, be that central bank policy swings, trade bans, election results or Brexit.
“Investors have been driven into investments where they have very little capability for dealing with what is on their plate,” Mr Weber observed. “You can nowadays see the entire return that you expect for a year being wiped out for a single day move in the market. And that is an unprecedented situation.”
This is just one banker’s view. But it comes from a man who has been at the centre of the system for decades and is not a natural alarmist. Investors, in other words, would ignore this three-part list at their peril.
So would Mr Weber’s former colleagues - at central banks.
