‘Planet Earth To Policymakers’: One Bank Sends An Urgent Message

Pretty much everywhere you look, growth concerns are proliferating.

One of the most dangerous aspects of the Trump administration’s trade war was the timing. With fiscal policy hamstrung by pretensions to retrenchment across various locales, monetary policy shouldered a hefty load when it came to reflating the global economy in the post-crisis world.

That, combined with an acute fear of what normalization might ultimately entail for asset prices, meant monetary accommodation lasted longer than it probably should have, setting the stage for “quantitative failure” – a state of affairs where central banks bump against a downturn with i) little in the way of room to grow balance sheets and ii) rates uncomfortably close to zero at best, and still mired in NIRP territory at worst.

Trump’s trade war cast considerable doubt on the prospects for global growth just as Fed tightening began to bite in earnest and just as the ECB began to take the first concrete steps towards normalization. We’ve also seen rate hikes from the BoE, the Norges Bank and now the Riksbank.

This is a dangerous mix. Policymakers have likely already “missed the window”, so to speak, and they can ill afford to wait any longer when it comes to freeing up some counter-cyclical breathing room. But that normalization effort is now colliding with slowing global growth and has the potential to make things worse just as trade frictions are starting to manifest themselves not just in souring sentiment, but in the actual data.

Plunging crude prices and collapsing breakevens are the poster children when it comes to illustrating how the reflation narrative is being bled dry.

(Bloomberg)

And here is your top-down credit/liquidity impulse fading:

(Bloomberg)

It’s against this backdrop that BofAML is out with a new note called “Planet Earth to Policymakers: Please Reflate.”

The title speaks for itself. The bank is worried about global growth expectations, which they characterize as “in free fall.”

To support their contention, they cite The Duke University CFO Survey. “In the latest quarterly CFO survey (December 12, 2018), confidence in the world economy has collapsed to levels below early 2016, and about the same depressed levels of late 2011/early 2012”, the bank writes, before reminding everyone that “both those episodes were followed by global central bank easing”. This time, by contrast, we’re getting central bank tightening, as detailed above.

BofAML warns that the data from the CFO confidence survey is an “excellent leading indicator” of regional PMIs one quarter forward. To wit:

They predict the US PMI to be 50.3 by February 2019 (from 59.3 in November 2018), the European PMI to be 45.9 (from 51.8), the Asian PMI to be 46.3 (from 50.6), and the Global PMI to fall to 47.3 by February 2019 (from 52.0 now). We don’t think policymakers are in tune with these potential declines.

And here are three of the regional surveys that show the net proportion of CFOs who are more optimistic on their respective economies than they were one quarter previous:

The bottom line, from where BofAML is sitting, is as follows:

Financial markets and CFOs think the world economy is in real trouble. Policymakers are oblivious to this scenario. One of them is going to be wrong. Past history suggests, the policymakers. The science experiment of Quantitative Tightening might be halted, the Chinese credit impulse is still in free-fall and might need to be revived a lot more dramatically, and global fiscal easing could be a lot more muscular.

The bank seems to believe that policymakers will wake up to this reality in 2019. It’s also worth noting that BofAML is hardly alone in positing that the rest of the world will ultimately follow the U.S. in pursuing aggressive fiscal stimulus.

This is a rather vexing quandary. We can either:

• plunge further down the monetary policy accommodation rabbit hole just when we were starting to claw our way out and throw in some fiscal largesse for “good” measure

or

• risk a deflationary bust