Ok, well former trader Richard Breslow is out with his latest and he’s got a thing or five he wants to tell you about central banks and markets.
What you’ll read below is in many ways similar to the notion that excessive policymaker transparency is fostering dangerous feedback loops in markets by effectively making it impossible for anyone to form a long-term view. This concept was expounded most effectively and most eloquently late last month by Deutsche Bank’s Aleksandar Kocic.
The only difference would seem to be that Breslow believes a return to normalcy (where “normal” means rebuilding the fourth wall between markets and policymakers) is possible. And it’s important to differentiate between “desirable” and “possible.” Yes, two-way markets make price discovery possible and markets ceased to function in that capacity years ago. So it is unquestionably desirable that we return to a state of affairs where markets can function properly.
The problem now is that the state of exception has become permanent. There is no real way out of this. Maneuverability is limited and if inflation or deficit spending forces the Fed’s hand, volatility will return. But that’s not the problem – the problem is that volatility will return with a vengeance. Breslow seems to acknowledge that, but also seems to think there’s some middle ground whereby gradual but consistent tightening can somehow be pulled off while preserving enough transparency to keep things from falling apart completely.
That is probably a dubious assumption and that doesn’t even take into account the fact that, as Stephen Poloz learned recently, even if you do manage to reclaim some semblance of independence from markets as a central bank without tanking everything and driving up volatility, you still risk undercutting the economy. You cannot be the only hawkish central bank in a world that’s in the thrall of competitive easing regime and the currency war that comes along with that.
In any event, do read Richard’s latest, found below…
Later this week, we get to finally learn who will win the Fed Chair sweepstakes. And if there is one thing I would say to the nominee it’s that I don’t care what you think. That’s actually not true. I want to know how you’re leaning, but don’t think it’s a good idea to know what everyone thinks. Markets survived quite well, even better, with some uncertainty. Excessive and painfully explained forward guidance had its time and place. It’s now a negative, in every sense of the word. It’s not only an emperor and his clothes problem for the speechmakers, but it limits their ability to actually enjoy the benefits of optionality they think they have while it leads investors to dumb decisions.
- We have this notion that rate changes need to be fully — which somehow has come to mean no less that 70 percent — priced in to be justified. That is just not so. Especially in an era when all of 25 basis points is an excruciating decision. It’s just not credible to warn that traders may be taking excessive risk and then serially infantilize them. The measure of success of any monetary policy move can’t be “the market took it well.” Remember, it’s supposed to be about the economy. And that’s not stupid
- We keep harking back to the “horrifying” days of 1994 as some bizarre object lesson of why policy tightening is something that must be done with the gentlest of hands. Nonsense. The message from then was traders need to actually pay attention to what is going on around them, realize they are not bigger than the market, have even a little modicum of risk management discipline and listen to the real messaging, not the oratory at every rubber chicken breakfast. Rates started rising in February, no one listened, and it wasn’t until 4Q that traders radioed, “Houston, we have a problem.” That was all on the market, not the Fed, and for a brief window in time the notion of averaging down was reevaluated
- Which brings us to the real issue at hand. There’s so much toxic waste passing as investments that no one, including, or, perhaps, especially, the Fed has any idea how the private sector gets out of it. There’s a real possibility that the Fed celebrates that its balance sheet is getting in order but everyone else is left holding the bag. Central banks have created a vicious positive, which functions as a dangerous negative, feedback loop. They need to keep markets from panicking, which only makes them more reckless. It’s a sad shame that we have come to call fixed income selloffs as “tantrums.” It suggests that the people to blame are the investing class
- So as a new Chairman gets set to be anointed, what do they do? And what should investors expect? Exactly what Chair Yellen is hinting and no one is listening. Relentless and gradual rate hikes. Debating whether the three hikes penciled in for next year fits the dual mandate is a fool’s errand. Absent conflagration, they are coming. There is no other choice. It’s the only way to, over time, nudge the carry addicts out of their malaise. Whether the yield curve continues to flatten or steepens is where the economic debate about the need for hikes is being played out, but the hikes are coming
- This is why the speeches are counterproductive. Various hawk and dove factions publicly anguish over minutiae while obscuring the real imperative. Policy rates are going higher because if not, it’s huis clos