For all the talk about how investors and traders hang on every word that comes out of policy makers’ mouths, when you actually think about it, central banks’ reflexivity problem effectively allows markets to interpret everything as dovish.
Or, put differently, every hawkish lean is interpreted as a bluff that is immediately called and every dovish spin is just another reason to BTFD. So in a way, it’s not entirely clear who’s “guiding” who in the whole forward guidance-markets relationship.
Realizing that, to quote Deutsche Bank’s Aleksandar Kocic, they were no longer “unalterable spectators,” but rather “alterable observers who are [themselves] able to alter,” markets began to simply mock anything that sounded hawkish. Simply put, every investor and trader became Josephine Witt…
Up until recently, central banks had kind of acquiesced to this state of affairs, knowing that if they needed to justify the continuation of the ZIRP/NIRP/QE regime, they could always – always – find an excuse somewhere.
Data bad? Great. We’ll say we’re “data dependent.”
Data looking better? That’s fine too, we’ll just point to turmoil in China or else we’ll argue that fiscal policy isn’t ready to take the proverbial baton.
None of that applies? Fuck it, we’ll just point to “still” subdued realized inflation or at the very least, subdued inflation expectations.
But recently, you kinda get the impression they’re going to try and dig themselves out of this for real. Because it’s getting increasingly difficult to deny the market distortions they’re causing whether it’s absurd equity valuations, credit spreads that are increasingly detached from fundamentals, bonanzas for carry traders and vol sellers, etc.
So on the eve of the most important ECB meeting in recent memory, former FX trader Richard Breslow thinks it’s time to consider what happens in an environment where forward guidance has to be taken some semblance of serious.
Read his full note below…
We used to think of forward guidance as an important, long-term, device in the central bank tool box. It was meant to direct investor, business and consumer behavior through the vicissitudes and noise created by what seem seminal but are often random events. It was what convinced investors that buy and hold, augmented by gobbling up every dip, was a winning, and protected strategy. A way of saying, you can listen to every speech on the schedule but this is what the people that matter are telling you.
- This is in the process of morphing into a much more tactical tool and it’s worth keeping up with the changes. As the timing of global central bank actions diverges, it won’t always mean the same thing at the same time to everyone
- For years we were meant to understand that low, lower, lowest rates was where we were going and staying. That was easy. No one had to do anything. Then it changed to yes, but not forever, a message skewed by Chairman Bernanke’s initial missteps. Eventually that became we’re making a change. But we all knew their bluff could be called easily
- We’ve entered the latest iteration and it’s going to require actually paying attention. They want to tell you exactly what they intend right now. It means they’re unlikely to be dissuaded from their message absent truly exigent circumstances
- For good reason, we’ve gotten used to taking everything with a grain of salt. It’s probably better to err now on giving them a serious dose of the benefit of the doubt. Of course, if you believe you’re a better forecaster than they are, make your own assumptions and bets. This is a very healthy development
- Which brings us to today, the eve of what’s being taken as quite an important ECB meeting. Will they signal the beginning of the end of their aggressive quantitative easing reign? Lo and behold, Bloomberg News just reported that the economics staff will be proposing lowering inflation forecasts right through 2019. And, yes, the market reacted.
- Even though it’s said to be the result of lower oil prices. Which should, if you think about it, be laughable
- Brent crude was $57 a couple of months ago. Today it sits just under $50. It gyrates, it flies around (case in point below), it’s largely unpredictable, and they’re tearing up the playbook on it?
- Not hardly. They’re giving their latest iteration of tactical forward guidance and have found a plausibly deniable way to do it. And the Germans have to acknowledge the fact even while muttering “Verdammt, foiled again”
- It’s just that it’s not the time to upset the apple cart, no matter that the numbers have been getting better. You have to admit that it’s strange optics to bail out a bank one day and hike the next
- But while they’ve probably signaled their short-term intention, you’re free to make your own forecasts for the fall. Watching how markets react is relevant
- The euro sold off on the news, but has so far held 1.12 to the dollar, an important pivot. Euro Stoxx 50 futures jumped, as equities are apt to do on such news, but stalled out at the quite useful 21-day moving average. Another pivot. Bund yields are slightly lower but closed the gap left on April 24 after the French election, settling at another important level at 25 basis points
- And of course, Europe isn’t an island. What goes on elsewhere will have big effects on these assets, as well