Over the course of this year’s dovish pivot from global central banks (reinforced “bigly” on Thursday by the ECB), one key question raised by a number of skeptics revolves around the notion that monetary policy is inherently constrained by the fact that the normalization effort is still in its infancy.
While the Fed has succeeded in dragging rates off the lower bound, other central banks are still mired in NIRP and balance sheets are still bloated across the board.
The “ammo” question is one of the most pressing issues and the prospect that policy is constrained is being challenged on a daily basis by “new” theories about how far the boundaries can be pushed in terms of what, on the surface anyway, sound like lunatic assertions about debt monetization and deeply negative rates.
In addition to the above, there are questions about the efficacy of monetary stimulus or, more to the point, questions about whether any coordinated reflation effort will be hampered by structural factors that are impairing the functioning of the policy transmission channel.
This goes to the heart of discussions about the effectiveness of monetary policy and the efficiency of accommodation and stimulus vis-à-vis real economic outcomes. We’ve touched on these issues a number of times over the past two months.
With the above in mind, we thought we’d highlight a couple of passages from the latest note by Nedbank’s Neels Heyneke and Mehul Daya who regular readers will recall have written exhaustively over the past year on dollar liquidity and the interplay between global growth, trade and financial conditions.
“Global velocity of money is currently below 1, [meaning] that every dollar of monetary base and credit added to the financial system results in less than a dollar of GDP”, the duo writes, in a piece dated February 26, on the way to noting that “this is a combination of weak global growth since 2009 and strong growth in the world’s monetary base since then [and] it means that a large portion of money is either being saved (hoarded) or being used for balance sheet restoration.”
Heyneke and Daya go on to suggest that the US and China are the only major economies that actually have any “room” when it comes to cutting rates and from here, the only way for central banks to juice global growth is via further rate cuts or balance sheet expansion.
On Tuesday, in “‘Imported Trouble’: Why One Bank Sees Virtually No Upside For Stocks From Here“, we brought you some excerpts from the latest note by Barclays’ Maneesh Deshpande, who drew a parallel between what’s happening right now and the conditions that prevailed in 2015-2016. Here are the relevant bits from that post:
While plunging crude prices contributed to the “mini-industrial recession” that played out three years ago, that period also coincided with turmoil in China and a trough in the country’s credit cycle.
Obviously, the prospect of a “kitchen sink” stimulus effort from Beijing is one of the main catalysts bulls are hanging their hats on when it comes to a prospective (and sustained) revival of reflation trades. January’s tidal wave of credit creation sent the “right” message, and the headlines out of the NPC tip a more expansionary fiscal policy, but that’s small comfort to those who worry that the monetary transmission channel in China is impaired and that it’s not credit supply, but rather credit demand that’s the problem.
“In 2016, the Chinese authorities responded to the weakening credit conditions with significant fiscal stimulus, resulting in a rebound in US industrial production as well as 2016 earnings expectations”, Barclays’ Deshpande writes, adding that “the central question in our mind is whether the Chinese authorities will embark on a similar rescue operation this time around.”
Nedbank also refers back to early 2016, but before they get to that, Heyneke and Daya reiterate a point they’ve made before about higher commodity prices (read: reflation) and dollar liquidity.
“As China added liquidity after the GFC, it triggered an extension of the commodity cycle, driving a rally in commodity prices from 2009 to 2011”, they write, before noting that “these higher commodity prices added significant dollar liquidity to the global financial system.”
Contrast that with the lead up to the deflation scare in early 2016. To wit, from Nedbank:
As the Fed’s balance sheets stopped growing in 2014, financial conditions tightened. On top of this, commodities topped out and oil, the biggest one of the lot, fell from USD100 per barrel to USD30. This contraction in liquidity forced the central banks and regulators to add liquidity in early 2016. Everything changed after the G20 meeting in Shanghai and a risk-on phase followed in 2017/18. Tighter monetary policy in 2018 — stemming from higher US policy rates and a slowdown in the global monetary base — has driven financial conditions back to 2016 lows. Many commentators are, therefore, saying it is time for Shanghai 2.0.
The notable lack of participation notwithstanding, the performance of risk assets in 2019 and the recent resurgence of the reflation story (as documented lately by Nomura’s McElligott), suggests some of the assumed benefits of the coordinated easing effort have been “front-loaded” (to quote Nedbank).
For Heyneke and Daya, the question going forward is this:
Now it is a question of whether the central banks would follow through, how big the stimulus would be and whether it can overcome shrinking global trade that is leading to a contraction in global liquidity and economic growth.
That latter point underscores how critical it is that the ongoing trade disputes at the heart of the global slowdown are resolved. In that regard, it’s more than a little disconcerting that Donald Trump seems intent on ratcheting up the tensions with America’s other trade partners just as a Sino-US trade deal seems to be coalescing.
Nedbank concludes with an update on their “real-time” velocity of money indicator (it monitors, among other things, credit impulses, money multipliers and banks vs overall stock performance), as annotated and shown below.
We’ll leave you with one last passage from the note:
Our velocity of money indicator turned down in 2018 due to tighter financial conditions globally. The central banks will take centre stage over the coming weeks, and we will see whether they’re successful in turning our indicator back up again. The long-term trend of this index, however, is a concern. Monetary policy has become more aggressive since the turn of the century, but every high in our indicator is lower, notwithstanding these massive stimulus packages.