I don’t know if “wishful thinking” is the right term given that implicit in the notion that DM central banks will never be able to truly “normalize” is the idea that, at best, the “state of exception” ushered in following the crisis can never truly be lifted and, at worst, that the greatest experiment in the history of monetary policy has failed when it comes to creating a sustainable recovery, but if you think about things from the perspective of risk assets, “wishful thinking” probably works when it comes to describing the increasingly “consensus” view that policymakers will ultimately bend the proverbial knee to markets, in a sweeping global relent.
This week did not disappoint when it came to Fed officials underscoring and otherwise “confirming” Powell’s “patient” message delivered in Atlanta last Friday. Additionally, the December meeting minutes clearly suggest that a dovish pivot was in fact already afoot even if Powell failed to convey that in the presser.
Meanwhile, the ECB is staring down the prospect of having “missed the window” entirely and it remains to be seen how European assets will react now that the monthly, price-insensitive bid is gone, leaving only reinvestment flows and the “stock effect” to shoulder the burden at a time when the allure of USD cash and generalized risk-off sentiment has led to ongoing outflows from European equity and credit funds.
As far as the BoJ is concerned, it’s always the same story. The yen’s safe haven status complicates the normalization effort as any bouts of global turmoil catalyze FX appreciation which then undercuts the already tenuous inflation targeting effort. Meanwhile, the JGB market is moribund, and there’s a (very) solid argument to be made that the biggest tail risk of them all is some kind of meltdown/taper tantrum that suddenly sends yields surging (that may seem like a laughable contention right now, but the fact that it seems far-fetched is kinda the whole point – that’s what a “tail risk” is).
With that as the backdrop, we wanted to draw your attention to a couple of quick excerpts and visuals that underscore everything said above. We’re not going to put you through the intellectual wringer here because after all, it’s Friday.
First, note that Credit Suisse is literally “calling it” on the Fed. The title of a note out Thursday from the bank’s James Sweeney is: “The Fed hits pause.”
“We are shifting our Fed view, and now expect the FOMC to pause their quarterly tightening cycle imminently”, he writes, adding that while the bank “continues to anticipate two rate hikes in 2019”, they now “expect them to be delayed until the September and December FOMC meetings, rather than March and June.”
In support of that, Sweeney cites the marked deceleration in the data. Here it is, spelled out in the simplest possible terms:
We had initially expected a global growth slump to occur in the middle of 2019, leading to a pause in tightening in the second half of the year. That weakness appears to be occurring earlier than we had anticipated. ISM manufacturing fell sharply in December, confirming the downturn seen in European and Chinese manufacturing surveys. Poor growth momentum and shifting risk sentiment have led to a rapid worsening in financial conditions. Risky assets and commodity prices have declined substantially, and credit spreads have widened out to 2016-levels.
Obviously, the latter points about risk assets and commodity prices refer to Q4 2018 and while everything is getting a reprieve right now, it seems increasingly likely that the relief will prove fleeting.
To be sure, Credit Suisse still thinks the U.S. will ultimately dodge a “serious recessionary downturn”, but it’s worth noting that in Bloomberg’s latest analyst survey, the median probability of a recession in the next 12 months rose to 25%, the highest in six years.
Meanwhile, the latest edition of BofAML’s FX and rates sentiment survey includes the following truly hilarious visual which suggests that market participants are now increasingly unconvinced that there’s a way out of the rabbit hole:
“Respondents expect a cautious path ahead for Fed policy, with few still looking for hikes both this year and next”, BofAML writes, before delivering the punchline, which is that “ECB expectations continue to be pared back, with a quarter of respondents now skeptical that the ECB will be able to raise rates at all.”
Got that? 26% of respondents to BofAML’s survey no longer believe that the ECB will be able to get rates out of negative territory.
What happens, then, if we run up against the next downturn without sufficient countercyclical ammo?
For now, we’ll just leave you with a few excerpts from a classic note called “Umbilical limbo” by Deutsche Bank’s Aleksandar Kocic, the man who made the best S&P call on the Street last year.
In its core, policy response to the crises was an extension of what in a political context is known as the state of exception: Market laws had to be suspended to restore normal functioning of the markets. The intrinsic contradiction of this maneuver is resolved only by understanding that suspension is temporary. Stimulus will have to be unwound. However, the accommodation has been in place for a very long time, during which traditional transmission mechanisms have atrophied and investors’ mindset has changed in a way that has altered irreversibly their behavior, the market functioning and its dynamics.
Engineering a state of exception comes with considerable risk. The Fed (and central banks in general) carries an implicit responsibility for orderly reemancipation of the markets, which makes stimulus unwind especially tricky. This highlights the deep dichotomy of power: While a state of exception is an exercise of power, there is a clear tendency to disown that power. And the only way to avoid facing the underlying dilemma is to never give up the power. This creates a new status quo — a permanent state of exception.