In hindsight, January may well be remembered as the month when monetary policy makers ushered in a new central bank “put”, and if the history books do end up reflecting that, it will more than a little ironic.
After all, as late as December’s Fed and ECB meetings, Powell and Draghi were emphasizing “auto-pilot” on balance sheet runoff and confirming an end to net asset purchases, respectively. That, against a backdrop of weaker data stateside and a quickly deteriorating situation across the pond in Europe.
More than a few commentators suggested the Fed was well on the way to overtightening (i.e., making a policy mistake) and many of the same critics insisted that the ECB had clearly missed its window for normalization.
Fast forward six weeks and Powell has completely capitulated, while Draghi explicitly acknowledged downside risks at the January post-meeting presser. An “early” end to balance sheet runoff in the US and another round of TLTROs in Europe now seem like foregone conclusions.
Meanwhile, there are ongoing concerns about whether a world sitting on a massive debt pile is capable of handling rate hikes.
It’s against this backdrop that BofAML is out reiterating the idea that the central bank put is “still there”, especially in light of heightened political uncertainty.
“While the Fed has been tightening over the past years, now it is expected to be more prudent and flexible than what markets expected up to only a couple of months ago [and] having ended net QE purchases, the ECB is now emphasizing all the other instruments at its disposal to provide further policy accommodation if needed”, the bank writes, in a note dated Wednesday, adding that “the PBoC has also been stepping up the provision of liquidity, as well as measures to boost bank lending to the real economy.”
In the past, BofAML has emphasized that rates vol. is the best way to assess whether the central bank put remains in play. This is something we’ve been over on any number of occasions in these pages and indeed, rates vol. remains an outlier stateside (the chart below shows vol. ratios for equities vs. rates – top pane – and crude vs. rates – bottom pane).
When it comes to rates vol., BofAML reminds you that “no other measure best captures the cumulative effect of QE and the effect of forward guidance [as] the former accumulates assets and the latter anchors uncertainty about the future path of funding costs and the potential risk of re-pricing across the fixed income world.”
The following rather stark visual shows that while central banks have succeeded in keeping monetary policy uncertainty (as proxied by rates vol.) suppressed, politicians’ “implied vol” (as proxied by the global economic policy uncertainty index) has soared.
“Once again, Central banks are trying to safeguard the economic outlook when politics threaten to derail what years of accommodative policies across the globe have achieved”, BofAML chides, on the way to predicting that both the Fed and the ECB will likely lean dovish from here thanks to the fact that:
- the macro is slowing down,
- global tightening is starting to hurt and
- there is too much debt out there to “mark” vol higher.
The first two points there are self-evident and so is point 3, really, but here’s what BofAML says on the “too much debt” bit:
There is simply too much debt out there for central banks to allow volatility to rise too far too fast (chart 5). Hawkish messages are ultimately followed by dovish ones; we have seen that again and again. Vol spikes are not structural, we think, as central banks are in a path of “low vol monetary policy normalization”. In that format we see moderate risks and a slow burn wider in spreads.
Depending on your penchant for hyperbole, you can call this central banks being “boxed in” by their enabling of explosive debt dynamics which now necessitates a perpetual effort to keep rates vol. suppressed, or you could call it “careful management” on the way to an painstakingly slow exit from accommodation.
But whatever you call it, do note that politicians aren’t doing monetary policy any favors by keeping the world on pins and needles.
We’ll leave you with the caveat from BofAML:
Have central banks blinked? We think so, as once again, they have verbally intervened when politics threaten to derail what years of accommodative policies across the globe have achieved. However, with QE over, ECB dovishness may no longer have the impact that it once did.