Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

Wall Street and most global equity benchmarks rose sharply on Monday, as optimism around U.S. earnings and easing global trade tensions offset some of last week's worries over frothy asset prices, private credit markets, and U.S. regional banks.

More on that below. In my column today I look at the so-called U.S. 'debasement trade'. While debt and deficit worries are real and justified, the bond and currency markets suggest they are overdone.

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* U.S. banking system liquidity

Debate is intensifying around whether liquidity in the U.S. banking system is shrinking to the point that could soon pose funding, collateral and broader market risks. The Fed could soon end its QT program, bank reserves are below $3 trillion, balances at the Fed's overnight repo facility are almost zero, and usage of the Fed's Standing Repo Facility has ticked up.

Some observers say alarm bells are ringing, and point to the recent wobbles in private credit and regional banks as evidence. Others are less worried, noting that while aggregate liquidity may be tightening, it is still plentiful and the Fed has several tools at its disposal should it need them. In short, there's no cause for concern.         

* Reading China's GDP tea leaves

China's headline Q3 GDP figures showed stronger-than-expected quarterly growth of 1.1% and annual growth of 4.8%, which was slower than Q2 but in line with forecasts. On the face of it, China seems to be managing to shrug off the trade tension and tariff uncertainty. 

But under the surface, there is perhaps more cause for concern. House prices continue to fall, and more importantly, fixed asset investment fell for the first time ever, excluding the pandemic. An "alarming" development that points to downside risks for Q4 GDP, reckons Zhiwei Zhang at Pinpoint Asset Management.     

* The importance of rare earths

Following on from that, official Chinese data also showed that exports of rare earth magnets fell in September, reigniting fears that the world's top supplier could wield its dominance over a component that is critical for U.S. defense firms and makers of items from cars to smartphones. And increasingly central to U.S.-China trade relations.

U.S. President Donald Trump said he expects to secure a "fair" trade deal with China and plans to meet President Xi Jinping in South Korea next week. Trump and Australian Prime Minister Anthony Albanese signed a rare earths deal on Monday, and Trump said he is working on deals with other countries.   

The recent surge in gold, cryptocurrencies and stocks to record highs has sparked claims that the U.S. "debasement trade" is in full swing, but the bond and the foreign exchange markets tell a very different story.

The upward swing in some "hard" assets this year is undeniable. The 50% spike in gold and even more eye-watering gains in other precious metals, such as silver and platinum suggest investors are getting anxious about something.

Many have argued that this "something" is debasement - the fear that an oncoming inflationary storm could erode the dollar's purchasing power and the value of U.S. financial assets. 

The term "debasement trade" was coined earlier this year by analysts at JPMorgan, though they began flagging the idea last October, arguing that a Republican sweep of the White House and both houses of Congress would be bullish for gold and bitcoin due to expansionary fiscal policy. 

Fast forward to today, and debasement doomsayers are pointing to increased U.S. government borrowing and rising public debt projections as well as the resumption of Federal Reserve interest rate cuts at a time when inflation is about to enter its sixth consecutive year above the Fed's 2% target. 

But if we were primarily dealing with debasement fears, the dollar and U.S. bonds would be tumbling and Treasury yields would be spiking - and this isn't happening.