Former FX trader Richard Breslow – who has been remarkably restrained in his daily missives this week – is out on Thursday with some thoughts on what we’ve seen in FX and DM bond yields over the past 72 hours.
Needless to say, there’s been a coordinated effort to convey a hawkish message this week and one feeble attempt to walk it back notwithstanding, central banks have gotten their point across. Or at least they have if you ask the euro, the pound, and especially bund yields, which have nearly doubled since Monday.
This morning, Breslow makes an important observation about the Fed. By being the first mover in rolling back accommodation, the US has gotten a free ride. The Fed can hike rates while risk assets continue to benefit from the global liquidity tsunami spearheaded by PSPP/CSPP in Europe and the BoJ’s relentless effort to corner both the JGB and Japanese ETF markets.
Well, we’re about to see how markets cope with a little two-way action and if what we’re seeing in DM yields this morning is any indication, a “tantrum” (or two or three) just might be in the cards.
Here’s Breslow who reminds you that if Janet Yellen thinks we won’t see another crisis “in our lifetime,” she doesn’t know much about the frequency of tail events…
Well, if you like central bank excitement, you’re having a pretty good week so far. Round and round the latest messaging wheel has gone with the little ball settling in the hawkish slot. Of course, as we should all know by now, no sooner do the chips get swept away after all the stops have been run, then the wheel is spun again. And that is precisely the problem. We continue to live from hand to mouth in our attempts to return our economies to “normalcy”. Don Quixote would be very comfortable in the world we have created.
- Still, there are some important takeaways that are worth considering beyond the simple message that there will be an attempt to inch away from crisis policies. But remember there are certain classes of drugs that they just don’t know if they’ve worked until the patient is weaned off them. And despite any protestations to the contrary, extreme QE is one of them
- There has been a tremendous benefit to the U.S. from being first out of the gate in snugging rates. They were smart or, at least, opportunistic. The Fed has enjoyed free-ridership of doing so while everyone else is still printing away. This has meant that financial market conditions have taken it wholly in stride. To assert that this will be the case when everyone else join is making a big assumption about the efficacy of the cure
- Investors remain properly skeptical about the timing and speed of any rate hikes. This latest run-up in euro and sterling may have as much to say about how we’ve structured liquidity provision in the modern marketplace as a view that a baby step on rates really changes the world. I’m as impressed as anyone with the “spike” in bund yields.
- But we’re talking about a move up to 42 basis points. And you won’t have heard the last from Mario Draghi if his currency really starts motoring
- Asset prices are somewhat elevated. But there aren’t any bubbles. However, rates need to go up to deal with this profligate risk-taking. Which we don’t see as currently a problem. The bottom line is, investors are utterly convinced that, push comes to shove, the “put” is very much alive. And they’re very much correct
- If you really want to pour cold water on all this optimism, consider the dangerousness of the thought that because of all the great things that have been done, it’s unlikely there will be another global financial crisis in our lifetime. If this is a view that is circulating behind the closed doors of central bank meetings and forums, we’re in a lot of trouble. Black swan events happen a lot more often than they’re supposed to. And often because it’s to the benefit of special interest groups to see how close we can get to the edge. Incrementalism can be a nice word for chipping away
- One last thing on a different but obviously related topic since inflation expectations play such a big role here. Oil is a financial instrument first and makes your car go second. It’s made five distinct moves so far this year, signifying nothing but having policy forecasters running to their extrapolators each time