Brexit speeds up U.K. decline

Plus more interest rate drama, Rubio’s pro-union ploy, SPACs, Hu drop

Welcome to another edition of Contention, just about seven minutes of dissident business news. This week we cover:

  1. Rates tick up as bond glut worsens

  2. Brexit speeds up U.K. decline

  3. Rapid Round: Amazon union’s bipartisan boost, SPACs lag amid rate climbs, Ant CEO bows out

Important note: Contention is going on Spring Break next week, so we won’t have our normal newsletter on Monday. We’ll have a column explaining some of the important concepts we’ve been talking about lately but haven’t really had the space to lay out in detail. We’ll be back the week of the 28th.

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Rates tick up as bond glut worsens 

Equity markets bounced back from recent losses last week, with both the Dow and S&P 500 notching record closes. The week’s dominant story stayed the same -- rising interest rates fueling a “rotation” away from long-term innovation plays. The Dow gained 4.1% on the week, the S&P 500 2.6% and the Nasdaq 3.1%.  

Now the fruits of ongoing state efforts to prop up capital are beginning to ripen, with a bumper crop of liquidity threatening more problems for financial institutions this year.

These problems showed up in three U.S. Treasury bond auctions over the course of the week. None of their outcomes shocked investors, but all showed clear bearish patterns for government debt

Tuesday’s $58 billion auction of 3-Year notes was the strongest, but Wednesday’s $38 billion sale of 10-Year bonds “tailed,” meaning that demand fell below pre-auction expectations, driving rates up. 

Thursday’s $24 billion auction in 30-Year bonds ran into problems as well, with a 30% drop in foreign buyers from February’s sale and a below average “bid-to-cover ratio” -- a sign of weak demand as each bond received fewer purchase offers than normal. The dollar index hit a weekly low following the auction. 

Things are not looking much better moving forward. Last year’s “Supplementary Leverage Ratio” (SLR) exemptions allowed banks to increase their Treasury holdings by 33.5% and their reserves at the Fed by $1 trillion. Normally banks would have to treat these as assets -- they get paid interest on both of them -- and hold capital against them. Exempting them from SLR calculations allowed banks to increase their balance sheets by as much as $600 billion.

The Fed expected the policy to encourage banks to lend more, but it did not -- they actually tightened credit and increased their capital anyways. Where it did help was in propping up the Treasury market, and as the SLR exemption expires at the end of the month it could mean bond unloading to the tune of $200 billion or more

Add on top of that problem, $1.9 trillion in new stimulus finally passed last week. Not only will that mean a huge new supply of debt for the government to sell, it will also send out $410 billion of it in stimulus checks and another $246 billion in enhanced unemployment. Most of that money will go into bank accounts, liabilities for banks -- they pay interest out on them -- that count against their balance sheets. 

Again, these balance sheets are heavily regulated, so banks will have to sell off even more assets to make room for all these deposits -- this includes selling Treasury bonds, or at least not buying many. At this point even extending the SLR exemption won’t be enough to absorb all of this cash -- bond markets are set for a glut, plunging prices, and raising rates.  

Capital markets exist to allocate investment dollars into the places they need to go if the system of production -- and the society built on top of that system -- is going to reproduce and expand itself. Insufficient outlays in any space will cause price increases, which means higher returns for those who invest there. 

The pandemic blew up supply chains, i.e. the system of production as it has been built out over decades. That means a rapid, unprecedented redeployment of capital, with price signals all across both material and financial markets screaming in response. 

Governments have stepped in to try and prop up those on the losing side of the shift while tamping down discord in their labor forces through direct assistance. Rich country central banks have used their limited tools -- debt issuance and purchases -- to these ends, while poor countries are roiling with unrest over pricing chaos

Manipulating bank balance sheet rules to try and unleash private credit that never came is just one way the Fed tried to pull this off, and now it has backed capital markets into a corner where rates are likely to soar regardless of what the economy does. In the meantime, official narratives will blame “overheating” to justify austerity measures down the line. 

The good news: forces beyond the financial markets mean big growth is likely this year no matter what, but if the last year taught us anything it should be skepticism about forecasts. If the rosy predictions turn out wrong, rising interest rates and inflation will mean stagflation and deep suffering. How the banks and government will respond then is anyone’s guess. 

Brexit speeds up U.K. decline

The United Kingdom last week got its first statistical report card since its final withdrawal from the European Union on Jan. 1, and the marks were disastrous. Exports to the bloc fell 40.7% in January alone, with imports down 28.8%. It was the worst month for British foreign trade since the Office of National Statistics started tracking the current dataset in 1997.

One German economist put it bluntly: “foreign trade with Britain has collapsed.” But like everything Brexit-related, the story is complex, signaling the unpredictable decline of capitalism’s first great power. 

Britain’s split from the Union was supposed to be eased by their 11th-hour Trade and Cooperation Agreement (TCA), an interim economic deal headlined by a “zero tariff, zero quota” pledge between the parties. But the TCA neglected to cover key non-tariff barriers to trade, including health and safety inspections and other customs paperwork clogging up commerce between the two sides. 

Chief among these unaddressed concerns: “rules of origin” that slap tariffs and quotas on trade goods that contain parts sourced from third-party countries. Without such a rule, there’s nothing stopping either side from undermining all of the other’s trade agreements. With such a rule, the “zero tariff, zero quota” promise means very little.

The results: at least half of all British manufacturers have found major obstacles blocking exports to Europe, sharply increasing supplier delivery times, and a 67% increase in empty truck shipments returning to France.

Prime Minister Boris Johnson’s government has responded by downplaying these consequences, calling them “teething problems.” But business groups have pushed back on this, pointing to an ongoing 69% increase in cargo rejection rates just last week.

Europe is not doing any better, however, especially with regards to COVID-19 vaccine deployment. The Union has lagged badly on the vaccine rollout, with only around 10% of its population immunized vs. more than 36% for the United Kingdom. 

The problem: E.U. officials relied heavily on AstraZeneca’s shot because it was cheaper, but now the company is struggling to deliver supply. It is not, however, struggling to deliver shots in Britain, sparking European accusations of a secret export ban.

In fact, U.K. negotiators secured a more detailed contract with rights to terminate the deal and invoke penalties for any delays in delivery, while the E.U. contract used vague “best reasonable effort” language with few actionable consequences for the company. Now the bloc’s inability to deliver has prompted some of its poorer members to seek doses from Russia and China.

Brexit fumbling has also stoked new fears of sectarian violence in Ireland. On March 3, Johnson announced a unilateral extension of the grace period allowing unchecked food and parcel imports into British-occupied Ireland. These six counties share a border with the Republic of Ireland, an E.U. member. But 1998’s Good Friday Accords prohibit border controls there, so the counties have remained in the E.U. common market, with border controls supposed to be enforced between its ports and Great Britain’s. 

Predictably, the rollout has been disastrous, with shortages hitting grocery shelves in the British-controlled counties in January. Johnson’s move to extend the adjustment period without consultation outraged Europe, threatening member state ratification of the TCA -- an even worse scenario than the status quo. Two days after Johnson’s announcement a coalition of right-wing pro-English paramilitaries announced their withdrawal of support for the Good Friday Accords

A world historic rotation out of one way of life into another happens slowly, and it means rotation in political leadership as well. Britain’s decline from great power status has been going on for decades, but Brexit marked an important acceleration in its marginalization on the world stage. Now the fights it is picking with outside rivals and its own internal agitations threaten to only feed the process further. 

Stay tuned to see how its friends and allies follow behind. 

Rapid Round

Amazon union vote nears, Rubio… supports?

Amazon workers in Bessemer, Alabama are nearing a March 29 deadline to vote on whether to form the first union at any Amazon facility in the United States. The labor organizers say affiliating the warehouse’s 5,800 workers with the Retail, Wholesale and Department Store Union will give them more say on hiring, firing and speed of work -- at a company notorious for its demanding schedules. “We have a relationship with a computer and an app,” one warehouse worker said.

The organizing effort has picked up more political support than usual in American politics. U.S. President Joseph Biden referenced the Alabama workers in a statement earlier this month, without mentioning Amazon by name. Florida Republican Sen. Marco Rubio endorsed the union vote on Friday, describing Amazon as a “company whose leadership has decided to wage culture war against working-class values.”

Rubio’s statement took another jab at the PRO Act, which if passed by the Senate would encompass the largest and most favorable changes for unions since the 1935 National Labor Relations Act. Rubio said the PRO Act would encourage an “adversarial” relationship between labor and management. Rubio’s adversarial relationship with Amazon is over a different issue: the company announced Thursday it’s pulling all transphobic books from its online store, sparked by Rubio’s advocacy for one anti-LGBTQ title.

SPAC frenzy cools

The frenzy for special-purpose acquisition companies, or SPACs, continues with 240 so-called blank-check companies -- worth a combined $76 billion -- going public so far this year as of March 10. This is despite a 17% drop in the value of SPAC listings since a peak in February. Short sellers in recent weeks have also tripled their bets against the companies to $2.7 billion.

Rising bond yields prompted some of the exodus. SPACs are shell companies that seek to acquire private companies and take them public with looser regulatory requirements than traditional IPOs, which makes them attractive for rumor-driven speculation. Celebrities have lent their clout to their marketing too, prompting the U.S. Securities and Exchange Commission to warn investors to not make decisions “based solely on celebrity involvement.

Massive fiscal stimulus and low interest rates helped fuel a runup in price. But speculation in SPACs is comparatively less attractive when bond yields move up -- benefiting banks, energy, industrial and discretionary consumer sectors that stand to gain from a reopening economy.

Hu resigns in face of antitrust crackdown

Ant Group CEO Simon Hu resigned on Friday, months after Chinese regulators put a halt to the fintech giant’s IPO -- which would have been the largest ever. Hu’s resignation came days after the Communist Party’s “two sessions” wrapped up and antitrust regulators reportedly mulled a billion-dollar fine on Ant’s affiliate Alibaba for anticompetitive practices.

Beijing has made curbing the interpenetration of finance and technology companies a top priority since last year -- seeing the mixture as a source of potential risks to the wider economy. “Financial institutions must serve the real economy,” Chinese Premier Li Keqiang said during a speech to the National People’s Congress this month. Li added that a “deviation correction” mechanism should either adjust or block new financial products when necessary.

Alibaba’s business practices such as “choose one out of two” might also soon be on the chopping block. The term refers to the company punishing some merchants who sold goods on rival platforms as well as Alibaba, moving them down search results or not including them in promotions unless they sold on Alibaba alone. Besides a fine, China’s regulators could force Alibaba to divest from some assets not directly related to its primary ecommerce business.


Our only investment advice: Keep it especially trill. 

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