It shouldn’t really come as a surprise that policymakers the world over have seemingly slammed on the brakes when it comes to the short-lived global tightening effort.
It’s hard to wean somebody (and in this case, “somebody” is the market) off a powerful drug and monetary accommodation (especially in its post-crisis incarnation) is pretty potent stuff (“blue magic, that’s a brand name”).
In addition to the “addiction liability” and the fact that a word awash in debt isn’t exactly conducive to higher rates and tighter liquidity, global growth is now clearly slowing and if you’re a monetary policymaker, you don’t very well want to exacerbate that by persisting in a hawkish bias.
Hence, the dovish Fed pivot, the ECB’s acknowledgement of downside risks (and likely relent in the form of something, although we don’t yet know what) and, on Wednesday, the RBA’s Lowe shifting to a neutral stance.
On Thursday, the headlines center around the EC forecast cuts and, just hours later, the BoE’s downgraded outlook which saw the bank slash its 2019 and 2020 growth predictions.
Carney sounds less than amused with the political drama. “The economy is not ready for a no deal, no transition Brexit”, he said Thursday, adding that the “fog” from the ongoing soap opera “is creating tension.” A no deal Brexit, he says, “could mean a substantial economic contraction.”
All of this after the RBI cut rates overnight in a surprise move that stinks to the high heavens of political pressure a few months on from Urjit Patel’s resignation.
“Funny how that ‘slowing global growth’ thing works”, Nomura’s Charlie McElligott quips on Thursday morning, before flagging all of the above. To wit, from his morning note:
More ‘growth scare’ pile-on” as:
- the EC slashes their Euro-Area growth- and inflation- forecasts, while too we see
- the RBI shock with a surprise rate cut earlier overnight (after the RBA pivoted hard from hawkish to neutral earlier in week) and
- the BoE too cut their forecasts as well, showing the scale of the slowdown fear (alongside idiosyncratic Brexit risk) permeating global central banks
What should you make of it all? Well, as alluded to here at the outset, it means “the 2018 ‘hawkish normalization era’ is long-gone”, Charlie goes on to write, adding that “instead, we have resumed the ‘race to zero’ posture, as globally, central banks scramble to be ‘more dovish’ than their neighbor.”
For McElligott, that may “drive further USD strength, as the by-far ‘best of an ugly bunch'”. We talked about that at length on Wednesday in “We’re Gonna Need ‘More Manna From Heaven’: Questions Swirl Around Nascent EM Bounce.”
Next, Charlie contends that the Fed has shifted from a dual to a single mandate in the interest of leaning dovish.
“After ruminating on Powell since last week (and Fed speakers since the blackout was lifted), it has become clear to me that the Fed is now a ‘one trick pony,’ with broad ‘data dependence’ a myth in my eyes, and instead, now just a singular focus on INFLATION as their lone mandate”, he muses, before taking a trip down memory lane to recount the series of events that culminated in the February 5, 2018, VIX spike and XIV extinction.
You might recall that things were already moving in the wrong direction headed into that fateful Monday. Stocks and bonds were selling off together (triggering a horrible week for risk parity and balanced funds) and on Friday, February 2, 2018, the market was hit with a hotter-than-expected AHE print which then started tipping dominos.
Below is McElligott recapping in the context of US fiscal policy which exacerbated the situation last year by stoking fears that the Phillips curve might snap back to life like the villain at the end of a slasher flick to “exact its revenge“, to quote Powell himself. Here’s Charlie:
A point that I have made over the better part of the past year is best expressed through asking a simple question: “What was the catalyst that awoke last year and drove the new cross-asset volatility regime?”
My answer: “green shoots” on INFLATION is what shook markets and instituted the new volatility paradigm witnessed in 2018, where the “match” of explosive US fiscal stimulus onto an already “full steam ahead” US economy (which was running above-trend growth already) lit the US Rate Vol “fire,” and meant that for the first time in the post GFC regime, traders lost their visibility on the future path of US interest rates…especially as we saw a new Fed Chair enter the arena with perceived “hawkish” chops
As I have previous made clear, the late December 2017 / January 2018 “spot (S&P) up, VIX up” environment was a rather profound signal for the imminent “tipping over” of risk, and the catalyst of this volatility was the move in US Rate Vol (UST 10Y term premium from at the time near-cycle lows of -60 on Dec 15th 2017 up to just -14bps by Feb 9th 2018 / 3m10Y USD Swaption Vol from 52.3 on Dec 13th 2017 to 74bps on Feb 6th 2018)
The final “wage inflation” surprise signaled from the AHE YoY suddenly saw the long-dormant “Philips Curve” argument brought back to life as the seeming “death blow” to the “Goldilocks” narrative—and occurred on February 2nd, which saw the S&P 500 trade -2.4% on the session thereafter and more-glaringly, the leveraged VIX ETN “extinction event” on the trading day following (2/5/18), as S&P turned to dust, -5.4% on the day
The chart below illustrates what he’s talking about on the term premium and rates vol. in the third paragraph.
Now, McElligott believes, the Fed is focused squarely on inflation and thereby essentially following Donald Trump’s Twitter “advice” in leaning on subdued price pressures to help justify a dovish slant. That, in turn, makes any upside inflation surprise the clear risk.
“As such, a re-acceleration in inflation is without question the largest downside risk to the stock market, with regards to the view that inflation beat(s) / wages & earnings beat(s) would then see the Fed forced back into the picture,” Charlie continues.
So, that’s where we are on Thursday. The overarching takeaway is that it looks like global central banks are prepared to do a coordinated dovish pivot and the Fed has of course opened the door for this. It’s far easier for other central banks to lean dovish when the Fed has taken the lead.
The only question is whether we’re all plunging back down the easing rabbit hole too fast. After all, decisive dovish pivots from the Fed are a pretty powerful drug on their own. Maybe everyone else should just hold off and see if we can muddle through on the powerful high induced by Powell’s rhetoric before we go chasing the dragon.
As Frank would say, “anything more than that is just greed, son.”