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Today’s Points:

• France has lost yet another prime minister — and now its debt is riskier than Italy’s.
• The yen has dropped below 150 per dollar once more.
• And now Japan and the US have an identical inflation outlook.
• Bitcoin and gold (and stocks) are at records as investors bet on debasement.
• AND: It’s Nobel Prize week.

Politicians, Money and Debasement

Politics doesn’t matter to markets, until it does. The last few days have brought political shocks severe enough to shake some of the deepest-held investment assumptions. The conclusions are concerning.

First, France’s prime minister, Sebastien Lecornu, resigned after his proposed cabinet failed to pass muster with all the disparate elements of the governing coalition. Fiscal policy, or how to deal with an overhang of debt much more serious than the country’s neighbors, continues to be an issue on which its politicians cannot reach agreement. As a result, the yield on French OATS rose far more than other euro-zone bond yields. Confidence in French debt is so shaken that they now trade at a slightly higher spread than Italy’s equivalent BTPs. That hasn’t happened since the euro launched in 1999:

France has cycled through five prime ministers since the beginning of last year while Italy, notorious for its political instability, has had only Giorgia Meloni. Remarkably, the two countries have now had the same number of premierships — 45 — since their democracies resumed after the war. (The equivalent for the UK is 19.) If there’s a new sick man of Europe, his home is in Paris. Investors are taking France’s current political instability as a reason to punish French stocks. Even though most of the biggest French companies are multinationals with little exposure to their domestic economy, the CAC 40 index has lagged the rest of Europe by some 14% since the beginning of last year:

While this is very concerning for France, the conditions are nothing like the crisis that afflicted the euro zone’s sovereign debt from 2010 to 2012. The currency weakened only very slightly Monday, while 10-year German bund yields, at 2.72%, remain below the 2.9% they hit when Berlin rolled out a fiscal expansion plan in March. 

The relative calm is ultimately because the market assumes that France is far too big to be allowed to fail, and that the European Central Bank will tide it through one way or another. That was the proposition that markets tested during the earlier sovereign debt crisis. As Alberto Gallo of Andromeda Capital Management in London puts it, over-indebted nations have four options (assuming they don’t want to default): They can grow out of the problem, make others pay for it (the tariff solution sought by President Donald Trump in the US), resort to austerity, or print money.  

Austerity, Gallo suggests, has grown much harder in the more unequal society that was created by 15 years of quantitative-easing bond purchases, as it inevitably hurts the poorest most. Growth isn’t going to happen, and France doesn’t have the option to try to force others to pay. Ergo, the ECB will find imaginative new ways to print money to solve the problem. Rather than a crisis, as threatened 15 years ago, what lies ahead is a long and steady debasement. That shows up most obviously in very long bonds, with 30-year yields rising across the developed world:

The most startling rise has come in Japan, which has also administered a political shock. 

Tiki-Take-ichi

The market fallout from Sanae Takaichi’s surprise victory in the election for leadership of Japan’s ruling party continues to be startling. In early Tuesday trading, all Monday’s trends continued with stocks and bond yields rising and the yen weakening.

Within the stock market, the assumption is that a Takaichi premiership will be expansionist and help growth stocks, which can show rising earnings. For years, Japan has been dominated by value stocks, which look cheap according to their fundamentals, as companies have slowly adopted shareholder-friendly measures such as share buybacks and paying higher dividends. That has dramatically reversed, with MSCI’s Japan Value index lagging its overall Japan index by 2.94% since the start of last week — its worst performance this decade:

As Takaichi seems concerned to force consolidations in Japan’s over-competitive sectors, this might be a misreading. The companies that would logically be first in line to be bought would be those that show up on value screens. So it’s possible that this creates an entrance opportunity for value. That said, the recent rally has brought the overall Tokyo stock exchange to its strongest valuation in terms of multiples of book value since 2007. It does look as though the easiest victories for value have been won:

She has also revived the yen carry trade, which appeared to have exploded in summer last year, as much because of political developments in Mexico as anything that happened in Japan. That correction was sparked by the victory of Mexico’s own first female head of state, Claudia Sheinbaum, in an election that was worried would lead to an over-powerful and irresponsible government. Those worst fears haven’t been realized. Since the carry trade hit bottom last September it has, on a total return basis, beaten the S&P 500:

This means that Takaichi is seen as boosting the world’s supply of easy money. That might be a dangerous assumption. She is under huge pressure to reduce inflation, which is higher than many in Japan can remember. Much of that is driven by volatile food prices after a bad rice harvest, and the latest inflation numbers surprised on the downside, but investors think Japan will now let inflation rip as they expect Takaichi to try reviving the boom years of Abenomics. Remarkably, five-year inflation breakevens are now slightly higher than in the US. This was unimaginable for much of the last three decades — and if it comes to pass, with all the attendant public disquiet, the new Japanese government will likely go to great lengths to curb price rises. That will mean higher rates and, in all probability, a carry trade unwind:

For the time being, however, Japan’s political surprise has been added to the French crisis to feed the narrative that government fecklessness will grow even greater. That means a crisis of confidence in fiat currencies. And that creates clear beneficiaries.

Going for Gold

At the start of last year, Bitcoin traded just above $43,000. Twenty months later, the world’s largest cryptocurrency has surged nearly 190% to surpass $125,000 and broken its record high for the 10th time this year. It’s outpaced even the mighty Bloomberg Magnificent Seven index, up a little over 100% in the same period. It’s not hard to see why.

Trump’s pro-crypto regime has rolled back oversight and is advancing a friendlier regulatory framework. That has helped further institutionalization of the asset, thanks to the SEC’s approval of Bitcoin exchange-traded funds last year. Bloomberg News reports that investors put $3.2 billion into 12 US Bitcoin ETFs last week, the second-biggest week since they launched. The London Stock Exchange’s recent green light for crypto-linked exchange-traded notes follows a similar playbook. Those listings, set to go live on Wednesday, have added fuel to the interest in Bitcoin, which shows up both in Google searches and in its price:

Another driver is the “debasement trade” — waning faith in fiat currencies in the face of persistent government deficits and inflation. Monday’s Points of Return reiterated the growing fiscal problem. The hangover from the post-pandemic inflation surge remains, and has coincided with a a dose of dollar weakness. 

The latest political developments helped this trade, with the yen weakening 1.6% against the dollar after Takaichi’s victory and thereby offering yet more easy money to the rest of the world through the carry trade. France’s political crisis helped the euro slip as much as 0.6% against the greenback. One common thread from these two shocks is that they make higher fiscal deficits more likely.

The US government shutdown has prompted more to join the flight into gold and crypto. Bitcoin’s rally, in that sense, may still have room to run. Analysts at JPMorgan Chase expect it could climb to $165,000 by year-end, aligning with gold’s volatility-adjusted valuation. Gold’s status as the ultimate refuge remains unshaken. The S&P 500’s rebound from the lows of the Liberation Day tariffs initiated in April has been exciting, and it closed Monday at another all-time high in dollars — but its performance in gold terms tells a bleaker story. Under Trump, bullion’s dominance has been almost a one-way trade, and the S&P has dropped 20%:

Gold, which broke through $3,000 an ounce in March, is on the verge of $4,000. In addition to its haven attributes, Longview Economics notes that “near-vertical” price actions (not just with the metal but primarily with other asset classes) reflect exuberance and fear-of-missing-out (FOMO) buying:

In other words, broad-based signs of euphoria in markets have continued to build. That’s increasingly reflected in the message of our medium-term models, which are warning of a pullback. 

It generates such a signal when markets have become persistently and excessively “greedy.” Meanwhile, crypto enthusiasts are used to volatility, and regard warnings of a pullback as “normal.” What is important for them is its magnitude. Measures of Bitcoin’s volatility, as a crude proxy of the scale of potential pullbacks, indicate that it is coming of age and starting to mimic gold — although it still has some way to go:

Institutional adoption driven by pro-crypto regulations may well be hastening this maturity. Charlie Morris of ByteTree Group notes that with institutional investors’ allocations still less than 1%, there is potential for this to go much further. Beyond that, Stéphane Ouellette of Frnt Financial points to a rise in Bitcoin’s hash rate, the pace at which it's mined. The effort is increasingly spread across “politically unaligned nations with miners taking highly diverse forms.” This makes the asset accessible globally, hard to censor, and less affected by disruptions in any one location. 

Bitcoin’s run will end at some point. But its steadily reducing volatility suggests that the next pullback won’t be as painful as its predecessors. And now the crypto faithful who only know to remain perpetually long Bitcoin (or in other words, HODL) have been joined by those who are losing their faith in governments to avoid debasement.

—Richard Abbey
 

Survival Tips

It’s Nobel Prize week. Checking out Polymarket, it looks like bettors don’t think Trump will be winning the peace prize despite his determined lobbying; it sees him as a 3% shot, equal with Greta Thunberg. Sudan’s emergency response team is the favorite, followed by Yulia Navalnaya, widow of Alexei, and that sounds about right. The most famous living writers who haven’t won the literature Nobel yet include Salman Rushdie, Margaret Atwood and Thomas Pynchon; the favorite is Gerald Murnane. I can’t find anyone running a book on who will win for economics — any nominations out there?

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