Chasing The Dragon: A ‘Blink For The Ages’

On Thursday, in “Blue Magic: Addicted Markets Get Fix As Central Banks ‘Resume Race To Zero Posture’”, we detailed the coordinated global pivot back towards dovish monetary policy in the face of mounting global growth concerns and political tension.

Here are a couple of quick excerpts for anyone who missed that piece:

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.

In the wake of this burgeoning dovish capitulation, analysts continue to marvel at just how abrupt the shift was last month and, relatedly, at just how dramatic the “snapback” from the December risk asset rout has been.

As SocGen’s Andrew Lapthorne noted a week ago, the MSCI World’s 7.7% jump last month is the best start to a year since 1987. While 90% of the MSCI World fell in December, 88% of global stocks rose in January, a 20-year record.

(SocGen)

With that as the setup, BofAML’s Barnaby Martin is out with his latest and as usual, it’s great. Martin characterizes the central bank “blink” as “one for the ages.”

“In 2018, only 13% of assets across the globe posted positive total returns and only 9% of assets managed to outperform US 3m Libor”, he writes, before exclaiming that when you “jump to 2019, the picture couldn’t be anymore different.” As the following chart illustrates, “98% of assets across the globe have positive total returns so far this year.”

(BofAML)

That, folks, is the second best outcome in 28 years and it comes courtesy of what Martin goes on to call “one epic reversal” in central banks’ monetary policy stance.

He cites the Fed, of course, and also the ECB’s revised balance of risks, the RBA’s shift to neutral and the RBI cut (which was clearly political, but it nevertheless adds to the “dovish shift” narrative). We documented all of that in the first linked post above.

As noted on multiple occasions over the past week (i.e., since the Fed), a dovish relent by one major central bank naturally triggers similar moves from global counterparts. When the first mover is the Fed, that domino dynamic is even more dramatic.

“When the most important central bank in the world changes tack, others must follow or risk unwanted currency appreciation”, BofAML goes on to write, adding that “true to form, the number of global central bank rate cuts over the last 6m is now greater than the number of central bank rate hikes.”

This is a remarkable reversal of fortune (and “fortune” can be taken both figuratively and literally there):

(BofAML)

It gets better – and immeasurably so.

Martin goes on to describe the diminishing returns of QE, starting with the notion that the dovish lean has been “manna for financial markets.” Regular readers will recognize that characterization – it was employed a couple of days ago by Credit Suisse’s Kasper Bartholdy in the emerging markets context.

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Now, though, central banks may be bumping up against the theoretical limits of what they can accomplish. With rates still at historically low levels (and mired in NIRP in many cases) and balance sheets still bloated, the “out of ammo” problem may soon become particularly relevant.

“But after ~$11 trillion in central bank balance sheet growth since The Global Financial Crisis (using the “big 4”), the limits of monetary policy are being reached [as] central banks have much less capacity to effect economic change this time around”, BofAML goes on to write, before delivering the following delightfully amusing hypothetical that illustrates just how surreal the world would be if policymakers deployed a similarly dramatic easing cycle from current levels as that which was rolled out in the wake of the crisis:

Chart 8, for instance, shows where interest rates would be if central banks repeated their post-Lehman easing cycle, from today. Understandably, some of the numbers would be far out of the realms of possibility. Hungarian interest rates, for instance, would drop to -10%, Eurozone deposit rates would fall to -4% and US interest rates would be heavily in negative territory (-2.5%).

I’m not sure it would be entirely accurate to say those numbers are “far out of the realms of possibility”. It certainly seems that way right now, but as Albert Edwards wrote on Thursday, things look like they might get pretty weird going forward.

Finally, for those interested to know what “pushing on a string” looks like when charted in the context of post-crisis monetary policy, the following visual (which shows, to quote Martin again, “what has happened historically to global GDP momentum and global debt-to-GDP levels in periods when global central bank balance sheets have expanded notably”) is particularly poignant:

(BofAML)

This (to trot out the drug addiction reference again) is the very definition of “chasing the dragon” and it raises glaring questions about how effective another coordinated easing push can be in the face of the myriad headwinds to global growth that can now very fairly be described as “gale-force”.