Back on December 31, BofAML sent out an SOS to global central banks in the form of an urgent-sounding note called “Planet Earth to Policymakers: Please Reflate” (at the time, it was the latest edition of the bank’s “The Inquirer” series).
In it, they cited 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 wrote, before reminding everyone that “both those episodes were followed by global central bank easing”, not tightening.
Fast forward a couple of months and policymakers seem to have gotten the message.
The Fed’s overtly dovish tilt in the weeks ahead of the January meeting set the stage for a capitulatory set of policy statements and a similarly market-friendly post-meeting press conference from Jerome Powell on January 30. Since then, the RBA has shifted to neutral, the ECB continues to hint at forthcoming measures to shore up the flagging euro-area economy, the RBI has cut rates and Kuroda has tipped the possibility of more stimulus from the BoJ.
Meanwhile, China continues to pull the myriad easing levers at its disposal in an effort to bolster the engine of global growth and credit creation in the face of the trade war – at least one analyst expects an actual benchmark cut from the PBoC, a relative rarity.
It’s against this backdrop that BofAML is back with a new edition of “The Inquirer” and it finds the bank’s Ajay Singh Kapur all but demanding an end to central bank balance sheet contraction.
“The correlation of EM equities with the major central banks balance sheets is 0.94 in the past three years [and] world equities have a similar correlation of 0.94 since 2009”, Kapur writes, before asserting that “central bank balance sheets are the most important driver of stock prices, in our view, by lowering risk premia, and cutting off deflation risk.”
What’s especially amusing about this debate (and we’ve mentioned this before) is that popular pundits and financial Twitter personalities spent years suggesting that the correlations shown in the charts above were coincidence only to freak out in near unison in Q4 of last year when Donald Trump suddenly started shrieking about the “50 Bs”.
Before I get off on a tangent, let me steer this quickly back to BofAML, whose note contains the following warning which will be familiar to some readers:
The world monetary base is shrinking, only the sixth time since 1980 – each prior episode resulted in massive losses in Asian/EM equities (1982: -31%, 1990: -14%, 1998: -28%, 2000: -32%, 2008: -54% for EMs). In all five cases, Asia was in recession.
Why should this time be different? The US Fed’s projected balance sheet contraction of about USD40bn a month will likely reduce the US monetary base 13.8% this year (after contracting 10.7% last year), and the global real monetary base by 1.6%. After spending seven years telling us that the Fed B/S expansion was equivalent to rate cuts, we are now told that the opposite – B/S contraction is like “watching paint dry”. Ostensibly, this comes from heroic assumptions of a rise in the US money multiplier, even a potential doubling in three years.
Kapur proceeds to deliver a stinging assessment of the current state of affairs, reiterating several of the most poignant critiques of the system in the course of suggesting that central banks are either mistaking an equivalence relation for a theory or else are “oblivious” to economic reality.
It’s not clear which of those alternatives is worse, but in either case, the suggestion is that policymakers don’t know what’s going on.
“Stopping QE – or slowing the QE-induced growth of the monetary base – will likely lead to a sharp drop in M2 growth [and when] coupled with the secular drop in monetary velocity from the declining incremental productivity of debt, slower nominal global GDP (and EPS) growth is highly likely”, Kapur warns, before reminding everyone that the more indebted the world is, the stronger the money supply growth rate needs to be in order to “maintain a desired level of economic and earnings growth.”
He continues, noting that the above is “increasingly true for China, with its 253% debt to GDP ratio.”
If you ask Kapur, it’s still not entirely clear whether policymakers have come to terms with all of this. “Welcome back to the secular stagnation debate and the potential threat of a ‘too tight policy mistake'”, he chides.
Honestly, the above-cited note is so chock-full of headline-grabbing soundbites that you almost have to wonder if Kapur wasn’t trying to break a record for most quotables crammed into a 5-page piece of research. If so, he did a bang-up job. We’ll just leave you with one final excerpt:
Paraphrasing Mike Tyson, everyone’s got an investment strategy, until they get punched in the face by a shrinking Central Bank Balance Sheet. Monetary and liquidity analysis (different from “fund flows”) was popular in financial markets three decades ago. These days, eyes glaze over when we bring up base money growth, money multipliers, and monetary velocity. However, as the last decade has taught us, we should pay attention to this stuff.