When it comes to the March Fed meeting, Nedbank’s Neels Heyneke and Mehul Daya have a simple message for market participants:
… room for disappointment is huge.
I’m not sure we’d go that far, or actually, I guess what we would say is that “room for disappointment is huge” if Jerome Powell were to make the only mistake he can’t make, which we described in our Fed preview as follows:
All eyes (and ears) will be trained on the balance sheet discussion and it’s possible that a “failure” to adequately address the issue (where “failure” at this point probably means demurring on an announcement of the end date for runoff and then not providing any meaningful clarity beyond what we got in January) could prompt some indigestion from markets.
In other words, the only way things could go horribly awry is if the Fed delays an announcement on the end date for runoff and then inexplicably decides to provide little in the way of further color on the issue on top of what was tipped earlier this year.
Of course what counts as “meaningful clarity beyond what we got in January” is somewhat subjective and there’s an argument to be made that recent Fedspeak has covered every conceivable angle on this short of actually leaking the details. But the point is, Powell has surely learned his lesson by now when it comes to how much the market cares about this, so the idea that the Fed would delay an announcement on the end date for runoff and then fail to discuss the issue in any detail seems far-fetched.
Still, anything is possible and if the median dot still shows one hike in 2019 and somehow they (the Fed) come up short when it comes to delivering what the market wants to hear on the balance sheet, then “disappointment” could ensue. Here’s the full quote from Heyneke and Daya:
Investors have priced in that the Fed is likely to leave interest rates on hold for the rest of year, especially after the Fed’s sudden dovish pivot late last year. However, room for disappointment is huge, as the Fed would need to signal that its balance sheet runoff or quantitative tightening will end sooner than later. Should the Fed fail to signal this on Wednesday, we could expect a risk-off phase to materialize.
That’s from a piece out Monday and it also contains some other notable soundbites as well as some visuals worth highlighting.
Regular readers are familiar with the Nedbank duo who have been pounding the table on the consequences of a dollar liquidity shortage for global risk assets for almost a year and a half now.
Late last month, in the course of discussing the latest developments on the monetary policy front, Heyneke and Daya said the following:
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.
A couple of weeks later, they warned that the nexus between central bank liquidity injections and global trade is likely underappreciated.
In the absence of some manner of coordinated reflation effort from policymakers, trade growth could fall further, they said, especially in light of ongoing tensions between the US and the rest of the world.
When it comes to the nascent coordinated stimulus push, there are two main concerns, one related to developed market central banks and the other related to China. We discussed this at length in “China, Credit Growth And Diminishing Returns.”
Here are some key passages from that post:
When it comes to (loud) calls for central banks to embark on a coordinated effort to reflate the global economy amid mounting evidence to support the “synchronous slowdown” narrative, there are two potential problems with the notion that monetary policy can ride to the rescue.
The first revolves around the idea that developed market policymakers are constrained in their capacity to respond by i) rates that are at “best” barely off the lower bound and at “worst” still mired in NIRP, and ii) balance sheets that are still bloated.
The second problem pertains to the diminishing returns on Chinese credit creation. While a coordinated reflation push from developed market central banks would be a welcome development, the engine of global credit creation and, relatedly, growth, is China. So, markets are to a certain extent hanging their hats on the notion that a “kitchen sink” stimulus effort is in the cards from Beijing.
The fact that multiple RRR cuts and various other easing levers aren’t yet translating into the kind of real economic outcomes that would indicate things have definitively “troughed” suggests the policy transmission channel is still “clogged”.
Heyneke and Daya touch on some of the above in their Monday note.
“Global growth is slowing and China’s financial system is ‘clogged [as] the relationship between reserve requirements and M1 has broken down”, the write, adding that their measure of Global $-Liquidity remains in negative territory.”
Later in the piece, they fret that “jawboning” isn’t going to do it this time around. The following visual is Nedbank’s “Reflation Indicator” (see the footnote on the chart for details) which they note “was contracting through 2018 but reversed after the Fed’s dovish pivot surprise.”
That inflection you see over there on the right-hand side may or may not be sustainable, according to Heyneke and Daya.
“Further improvement would depend on whether policy makers can reflate the global economy/financial system via easier global financial conditions [and this will most likely require a liquidity injection and not just ‘jawboning'”, they write.
Finally, as a kind of addendum to the above, Nedbank reminds you that central banks have sought to foster asset price stability in addition to their inflation mandate. This, Heyneke and Daya implicitly chide, is no conspiracy theory. Rather, it’s a consequence of a credit-fueled financial system. To wit:
Central banks’ primary job is consumer price stability, but since the 1990s, the markets have also required that the CBs ensure asset price stability. A credit-fueled financial system is by nature a volatile system, but CBs kept policy rates below the Taylor rule for many years, helping to compress risk premiums and allowing more risk taking. This led to high debt levels and the perception that CBs are in complete control. We warn that CBs tend to be reactive and not proactive. Ultimately, sentiment and money supply drive financial markets and the global economy.
For now, forward guidance on both policy rates and G3 balance sheets has been enough to drive rates vol. into the floor as market participants again find themselves pondering the relative wisdom of owning vol. in the face of a renewed and reinvigorated attempt by monetary policymakers to effectively reinstate martial law following a turbulent 2018.
Whether or not the “policy impotence” trade ever gets any legs remains to be seen.
We’ll leave you with one last passage from the above-cited Nedbank note:
Global cross-asset class volatility (implied vol of bonds, commodities, currencies and equities) is too compressed and complacency among investors is high given the macro headwinds the global economy is facing.