Heads up everybody, Nomura’s Charlie McElligott is out with his Fed take and it’s comin’ in hot, dripping with delicious sarcasm and flaming derision.
On Wednesday afternoon (and all the way into Wednesday evening), we variously documented the Fed’s dovish surprise and the reaction it elicited from various market participants ranging from the financial Twitter-verse to Wall Street.
Some assessments of the committee’s decision to tip no hikes in 2019 and to not only announce an end data for balance sheet runoff, but to also unveil the operational details, were relatively subdued, while some betrayed a palpable sense of incredulity.
Well, suffice to say your colorful Fed take ain’t got nothin’ on that delivered Thursday morning from Nomura’s Charlie McElligott.
He kicks things off with a quote from Richard Koo and then proceeds to break his note down into two sections, the first is called “RANT”.
I don’t see much utility in trying to editorialize around this and it would be virtually impossible for me to add much to it in terms of out-Charlie-ing Charlie, so I’ll just present the “RANT” section verbatim and then break down the finer points in the other section later.
Via Nomura’s Charlie McElligott
Outside of this morning’s Brexit spasm…I’m going all-in on the Fed and our worst “Balance-Sheet Recession” past / “Japanifcation” / “end-of-cycle” worst fears seemingly being confirmed, which now looks to have indeed set us permanently stuck within “The QE Trap.” Richard Koo quotes, hashtags AND Wu Tang Clan references….get it all “hot” below.
Allow me to get this off my chest immediately: the Fed’s hilarious tightening / normalization “clown car” experiment (and ensuing credibility farce) is now complete, and I feel….vindicated.
I was openly dismissed / laughed-at by many, many investors late last Spring – early last Summer when I first-posited my “UST steepener” call (specifically expressed in a 5s30s curve cap) off the back of my long-held 2018 “Two Speed Year” thesis, based-upon a then-building “tightening ourselves into a slowdown” impulse which would metastasize- then-force the Fed to pivot away from “tightening” and towards “easing” as early as 2019—all because the market would experience a late 2018 “Financial Conditions Tightening Tantrum.”
Obviously this “Fed credibility loss” dynamic is nothing new for the institution, and in this case, the issue isn’t so much about the (pathetic) flip-flop driven by their tone-deaf failings last year into this year. Remember, three months ago the FOMC was projecting two hikes this year—now they’ve not just ‘nuked’ those to ZERO, but they also had to “TAPER THEIR TAPER” lolol—which net/net AGAIN shows a remarkably consistent inability from the Fed to see things coming which the market “somehow” consistently ‘does’ see. Thus, the Fed’s perpetually reactive / defensive posture (and fear of their own shadow).
Instead and on a larger horizon, the Fed’s credibility issue is about the simple-fact that for over 10 years now, market participants have already long-realized that, per the lessons of Japan from 1990-2005, the U.S. variety “balance-sheet recession” of 2007-09 would then lead us down the path of “the QE trap”…and here we are, “realizing” in real-time.
Let me turn it over to the master of this concept—Richard Koo—and this amazingly-prescient quote from LONG ago:
The QE “trap” happens when the central bank has purchased long-term government bonds as part of quantitative easing. Initially, long-term interest rates fall much more than they would in a country without such a policy, which means the subsequent economic recovery comes sooner. But as the economy picks up, long-term rates rise sharply as local bond market participants fear the central bank will have to mop up all the excess reserves by unloading its holdings of long-term bonds.
Demand then falls in interest rate sensitive sectors such as automobiles and housing, causing the economy to slow and forcing the central bank to relax its policy stance. The economy heads towards recovery again, but as market participants refocus on the possibility of the central bank absorbing excess reserves, long-term rates surge in a repetitive cycle I have dubbed the QE “trap.”
How’s that for seeing the future?