Via Nedbank, h/t Mehul Daya
In recent days a number of FOMC members’ (Bill Dudley, John Williams and Stanley Fischer) comments imply looming policy normalization (despite moderating growth and inflation). This amid tight credit spreads, record equity prices and falling bond yields (which are all reflective of easier financial conditions).
We have suspected this “third mandate” for many years, given the build up of financial stability risks amid the central bank’s unconventional monetary policies (as well as the “group think” inside the Federal Reserve).
The Fed might be the trigger for tighter financial conditions, but not the cause (as we believe the risk-on phase is very close to being over).
Financial conditions are influenced by global dollar liquidity conditions (petrodollars, velocity of money and collateral) which the central banks are not in total control of.
In the BIS 2017 annual report, the world’s central bank advises that policymakers should press ahead with the “great unwind” of stimulus, despite the expectation that there will be “some short-term bumps in the road”.
We believe financial markets will falter should policymakers go ahead with the bold decision of policy normalization of balance sheets (Total = $20tn and YTD = $1.1tn) as they have indicated.
Changes in EM FX and FI (and other risk assets) have become very correlated to changes in the size of the central bank balance sheet (for obvious reasons).