Ok, so what central banks did was, they went out and they decided to see what would happen if everyone (save Haruhiko Kuroda of course who, like his spirit animal Peter Pan, will never concede that he can’t fly) leaned hawkish all at once.
“Maybe the market won’t overreact,” they imagined.
That didn’t work out too well, because as it turns out, a little jawboning was all it took to set off a rates mini-tantrum:
So that’s yields on German, French, UK, and US 10Y government bonds since the hawkish procession in Sintra and obviously, this is a market that is not prepared to absorb a coordinated tightening effort.
What you see in that chart led directly to a rather nasty couple of weeks for systematic/programmatic strategies like CTAs and risk parity and just like that, reflexivity had given central banks a cold, hard slap in the face.
Here’s what Deutsche Bank wrote last week in “The Limit Is Near“:
EU rates have reacted quite strongly, as even such a modest change in language makes a big difference in a world where investors have become accustomed to central bankers finding reasons to maintain stimulative policies. This episode provides a good example of just how difficult the eventual path to policy normalization is going to be.
The biggest risk on that path to normalization is a correlated unwind of monetary stimulus, or the exact opposite of the correlated wave of liquidity we witnessed since the financial crisis hit in 2008.
For the time being, we think the central banks are not going to be able to go too far on their paths to normalization.
“Take a minute to let that sink in: the limit is near on policy normalization and they haven’t even started normalizing yet,” we marveled.
This was the state of affairs that led directly to Janet Yellen leaning dovish in her testimony on Capitol Hill and this is also the dynamic that paradoxically makes lackluster inflation prints like what we got in the US last week and what we got in the UK on Tuesday good news for central banks – it gives them an excuse to walk back an experiment in hawkishness gone horribly awry.
That said, each week the normalization process is delayed is another week that accommodative policy continues to create inflation in the “wrong” places – namely financial assets, which are fast approaching bubble territory if they’re not already there.
And so, with that as the backdrop, consider the excerpted passages below from Bloomberg’s David Finnerty who tries to make sense of this by taking central bankers at their word or, said differently, by (naively) assuming their newfound hawkishness has everything to do with expectations for rising inflation and nothing to do with a “shadow” mandate aimed at curbing this:
Inflation data continue to suggest investors may have jumped the gun regarding recent “hawkish” commentary from major central banks. Strengthening local currencies provide another reason for them to cool their rhetoric.
- Yes, the “QE and low-rate party” has to come to an end at some point. And market participants are understandably worried about how they will be weaned off the current highly-liquid environment. With global inflation still looking anemic, monetary tightening, if there’s any in the near-term, is likely to be at a very gradual pace
- Central banks appear to be striving for a “Goldilocks scenario” in terms of reducing liquidity, with no desire to create another taper tantrum
- U.S. inflation data last week has diminished the probability of another rate hike by the Federal Reserve this year. At this rate investors will be watching to see if the central bank lowers its 2018 dot plot in September
- The Reserve Bank of New Zealand is unlikely to want to repeat the episode of 2014, when it raised rates only to end up cutting them again. Given second-quarter inflation came in below estimates this week, hawkish commentary doesn’t appear a viable option at its August meeting, particularly as it would in all likelihood send the kiwi higher
- The Bank of Japan meets Thursday with inflation still being a long way from 2%. Hawkish rhetoric, therefore, hardly seems to be on the cards. If anything, the glacial pace of price gains means policy makers may lower their inflation forecast
- With Eurozone inflation flatlining in June on a month-over-month basis, the European Central Bank may put any reference to tapering on the back burner, particularly given the recent surge in yields. ECB President Mario Draghi is speaking at Jackson Hole in August, and he may well use that time, rather than this week, to test the tapering waters
- It’s even questionable how hawkish the Bank of Canada was last week. Yes, they raised rates and signaled that another one may be coming, but as always it appears it’s data dependent. Any disappointment there may see Stephen Poloz and his cohort singing a different tune
- If this keeps up, investors may very soon be watching the birth of a new breed of central bank bird: the “dovish hawk.”