This is just a short note, with little actual utility, but it’s about something that’s really bothering me.
Why are we so calm? What has anesthetized us?
I’ve had numerous conversations with market-makers in and around our business and many, not all, but many, seem very relaxed about the here and now. I hear: Spreads are coming in. Business is going to get better. The Fed will start to retrace the rise of interest rates before the middle of next year. The curve will shift down at both the long and the short end sooner than you think. Cap rates will retrace. On the first whiff of grape in this political environment, the Fed will drive borrowing costs down and probably start QE all over again. We’re going to have a soft landing, or maybe…we’ve already had our soft landing! No one cares about M1 or M2. No one cares about deficits nor monetary knock-on effects. Geopolitics is just noise. Domestic politics is just noise. What? Me worry?
Frankly, I don’t get it. We’ve got two shooting wars going on and a serious threat in the Pacific Theatre. These are real wars, folks. They aren’t police action dust-ups. We’ve got howitzers and cannons and missiles and tanks and jet aircraft. We’ve got tens of thousands dead. A big hunk of Europe is being ravaged in ways that make it look like it’s recapitulating the 1940s. The Mideast is on fire (and may get worse before I actually get this thing posted). Right now, a case can be made that there’s a real likelihood that we’ll be drawn into a shooting war (that assumes you don’t think we’re already at war in the Mideast or in the Ukraine. The enemies of our friends seem to think we are.)
Notwithstanding the recent performance of the price of oil, the Mideast war represents an immediate threat to the oil supply. While US production is up, our strategic oil reserves are at an all-time low, and various governmental actors seem intent on trying to suppress US production in service of our current green agenda. We’re still beholden to China for many strategic metals and an awful lot rides on Taiwan’s ability to continue to make and distribute chips to the rest of the world. The budget deficit is shocking and there is no serious conversation going on about what to do about it. Moreover, it seems both government and private market actors often act as if it doesn’t matter. Let’s be clear – both political parties are complicit. The current commitment to guns and butter is simply unsustainable. No one, and I mean no one, will even mention the third rail of middle-class entitlement programs. Talk about the elephant in the room!
Moreover, current projections of the deficit don’t really take into account what happens as the current weighted coupon of government debt rises from its current 2.9% to something closer to 5%. While math is not my strong suit, a 5% coupon on $30+ trillion of debt is close to $2 trillion a year…do I have that right? That change by itself will beggar our fiscal policy.
China and others are intent upon defenestrating us as the world’s reserve currency. If you haven’t thought much about that, don’t start now unless you like sleepless nights. Our economy floats on a sea of positive externalities of our status as reserve currency. Much of what we take for granted couldn’t occur if that status were really threatened.
The yield curve is intractably stuck at very high levels. It could steepen; it’s certainly not going to retrace any time soon. No one seems to really understand what term premium is, but we all understand that term premium is something. The short end is inextricably tied to Fed funds. While we may be enjoying a pause, I’ve not heard any credible case for a rapid retrenchment absent the super difficult and deep recession (which brings with it its own set of different but bad consequences). The curve is incredibly unlikely to shift downward at any time in the near future.
Closer to home, it’s been estimated that $1.5 trillion of commercial real estate loans will mature in the next couple of years. Most (a very big most) will struggle mightily to refinance. For many of those loans, and perhaps most, a 20% or 30% decrease in value will be realized.
How about our own politics? I just saw today a survey that suggested that 40% of Americans think democracy is kaput and think violence against your political foes is okay. I don’t think that’s ever happened before. The Republican party is a mess…a circular firing squad on a good day. The Democrats are now discovering significant fault lines over the Mideast war (yes, it is a war) and all the while, the Democrats and Republicans are drifting (or sprinting) left or right. The middle looks increasingly lonely. Then, we’re increasingly likely to see a rematch of Trump and Biden, and I don’t have to actually say what’s problematic about that, do I? All the country thinks the other half is lying all the time.
How about secular changes in the way commercial real estate is used? We’re not back to work yet, but will we ever be? And how about AI? (Just like our Vice President, I know that stands for Artificial Intelligence.) Disruptive technology? Creative destruction? Seems that way. Where it goes, where it leads us is absolutely unclear.
So why are we so calm?
Is it because there’s no obvious precipitating event looming on our immediate horizon? We actually rarely see bad things coming, do we?
As regular readers of this column might know, I am fascinated by the level of obliviousness around existential threats and events that change the course of history, the geopolitical equivalent of tectonic plates colliding.
Let me start where I often do with the obliviousness evidenced across Europe and North America in the months and weeks leading up to the commencement of World War I. The English were focused on Ireland; the Americans were focused on ignoring the fact that there was actually a broader world out there. The French were fascinated by the murder trial of Madame Henriette Caillaux (who was not convicted, even though she shot the poor man six times in the abdomen – Francophile passion was apparently a compelling defense.). It was summer and the high command of all the major actors were on holiday. (I have this mental image of fat, old, mustachioed German generals bobbing around in the hot springs of Baden-Baden wearing their pickelhaube and thinking about little else than mistresses, wine and gluttony…certainly not machine guns.) The Archduke Franz Ferdinand was assassinated in Bosnia on June 28 and no one seemed to smell the fuses’ sulfur sputtering. In Paris, the annual Grand Prix de Paris horse race went on. Someone apparently suggested that it was a tad tacky to do so in light of the death of one of the heirs to the throne of a major European power, but hey, the Austrians hadn’t really mattered all that much in the past 100 years, and the horse race, part of the patrimony of France, must go on! Peace, exit stage left.
Black Thursday happened on October 24, 1929, but the summer of 1929 was terrific and pacific. The Babe hit his 500th dinger. The Dow hit all-time highs, and everyone was all in. Joe Kennedy famously said that when you’re getting stock tips from the shoeshine boy, it was time to get out. He did. Most everyone else did not. Margin was king. The Roaring Twenties were still roaring. Prohibition, which was party catnip, turbocharged significant changes in social norms, the type of thing that only happens when anxiety over real problems abate. What could possibly go wrong?
How about 1941 in the lee of Pearl Harbor? Certainly, some of our military leaders in officialdom were concerned. The American public? Clueless. Poling suggested that while we thought war was possible, no one seem terribly troubled by the prospect. I remember asking my mom, who was aged 19 at the time and working in show business in New York, what she remembered. “Not much,” she said. More pressing matters of the next performance, her love life and fun occluded more serious thought it seems.
Lastly (and this is admittedly an unscientific survey), what about the GFC? Here, memories are sharper but for most of us who can remember, and aren’t pretending, we didn’t see it coming. I remember assuring my partners that the horrid mess in the subprime resi space (who knew no docs loans were risky!) was nothing that should concern us in the commercial real estate space or the broader economy. Investors would have losses, but they were paid for that risk and would move on. How bad could that be? We didn’t appreciate contagion. We didn’t appreciate how deep and jagged the hole in asset values would be. We didn’t appreciate how badly it would impact liquidity and how horrific the knock-on effects would be of the enormous damage to our major financial institutions. (I watched Too Big To Fail over the weekend – nausea inducing!)
The absence of some compelling precipitating event or compelling data sets screaming that the balloon is about to go up, is not all that comforting; not a good argument that nothing bad will happen. Maybe we glide by here. Maybe things are more benign, than I, at least, think they are. Maybe the economy avoids a recession. Maybe we adjust to high interest rates and business again thrives. Maybe the cost of money begins to rapidly go down. Maybe a much wider war is avoided. Maybe our politics recover from this fevered malaise.
I rather think not. But then again, given what I do, I am a professional pessimist. What am I going to do about all of this? Probably nothing. Get back to work, think about revenue projections for Q1, look forward to the holidays and hope all is well enough.
What? Me worry?