For now, anyway, global equities seem content to revel in the new paradigm, which is actually just the old paradigm with a negative growth bias.
The old “Goldilocks” narrative rested on two pillars: synchronous global growth (which allowed market participants to take an upbeat view on the economy) and subdued inflation (which argued for a cautious approach to monetary policy normalization that would ensure conditions remained some semblance of accommodative for the foreseeable future despite uniformly solid growth).
One thing that we and others began warning about some 18 months ago, was the distinct possibility that too much of a good thing in terms of synchronous global growth might ultimately tempt central banks to embark on a coordinated effort to normalize policy. That, we suggested, could end up conspiring with the fiscal stimulus push in the US, where an economy operating at full employment was turbocharged, potentially undercutting the “subdued inflation” story stateside, prompting the Fed to lean more hawkish than they otherwise might.
Ultimately, the worry was that an overly-aggressive Fed might coincide with an inclination towards normalization from other central banks to bring about a tightening impulse that was too much to handle for a market hooked on stimulus. If that were to play out against a backdrop where worsening trade tensions threatened the outlook for growth, it could create a perfect storm, which is pretty much what happened in 2018.
Perversely, then, the global growth slowdown has turned into something of a positive development to the extent a synchronous downturn was necessary to put the brakes on the monetary policy normalization push. Meanwhile, inflation remains just as subdued as before, if not more so. Hence the new “Goldilocks” narrative, where “just right” means the economy slows just enough to force a policymaker relent, but not enough to usher in a global recession and inflation stays muted, cementing the “monetary policy case” for more accommodation.
That’s essentially where we are now – back in limbo, chasing the elusive target that we really don’t want to catch. Because the ultimate irony in all of this is that while we all like to talk about how critical the “reflation” effort is, “too much winning” (to quote Trump) is indeed a bad thing if markets prove unable to digest even slightly higher rates and are unwilling to stomach the idea of central bank balance sheet shrinkage.
Goldman reiterates all of this on Monday afternoon – in far fewer words than I just did, by the way, underscoring a perpetual problem I have in these pages, where my “intros” end up being three times as long as the excerpts from the research I set out to quote.
“Amid slow growth and weak inflation, DM central banks have remained quite dovish”, Goldman writes, rehashing recent policymaker relents (and laments) from the ECB slashing its growth outlook and extending its forward guidance to the BoJ cutting its export and IP outlook.
“The dovish central bank approach is reflected in market pricing, where most policy rates are priced to stay either negative or flat for the foreseeable future, and fall in the US”, Goldman continues, underscoring what you already know. Despite this being repetitive, everyone should remind themselves of it each and every day, because what it effectively suggests is that the “state of exception” has indeed become at least semi-permanent.
Given Goldman’s expectation that the Fed will manage to squeeze in one more hike in this cycle after a prolonged pause (specifically, the bank sees the new Fed dots tipping no hikes in 2019, but one next year) you might be wondering if there’s any historical precedent for that.
The short answer is “not really.” The longer answer is that, to quote Goldman, “Fed pauses of greater than 6 months during hiking cycles are not common, having only occurred twice since 1980.”
So what is one to do assuming one believes, as Goldman does (and they aren’t entirely alone in this camp) that the Fed will get another one in after an extended break?
The bank says that since we’re near the end of the hiking cycle, “the closest analogue might be periods when the Fed has held policy rates relatively high for an extended period.” Here is what they came up with in terms of analyzing equity returns during those periods:
During four such periods since 1980, at face value we find equities tended to do relatively well, although towards the end or the beginning of each period performance appears more mixed. Of course, the tech bubble influences a number of these observations and any single period will have idiosyncratic dynamics. We continue to believe without a pick-up in global growth there are growing risks to the current rally.
Is that any semblance of useful? Well, we’ll leave that up to you to decide, but what’s probably more important (or at least from a big picture perspective) is that irrespective of whether the Fed hikes one more time this cycle or not, the overarching message from the past year is that it is exceedingly difficult to re-emancipate markets following the suspension of traditional rules.
As Deutsche Bank’s Kocic wrote years ago…
Engineering a state of exception comes with considerable risk. The Fed (and central banks in general) carries an implicit responsibility for orderly reemancipation of the markets, which makes stimulus unwind especially tricky. This highlights the deep dichotomy of power: While a state of exception is an exercise of power, there is a clear tendency to disown that power. And the only way to avoid facing the underlying dilemma is to never give up the power. This creates a new status quo — a permanent state of exception.