It’s central banks versus the deflation/disinflation boogeyman (again), and while it’s safe to say central banks “won” the first round, there are lingering questions as to whether the “policy impotence” trade will get traction later once it becomes apparent that the limits of monetary accommodation have been reached (and really, breached).
What’s “the first round” and what constitutes “winning”? Well, if you mark the beginning of this latest Michael Buffer special to January, when policymakers decided a dovish pivot in the interest of reinvigorating the reflation trade was in order, and if you couch “victory” in terms of financial asset prices (because what else is there, right?), then this is what “winning” looks like:
“Markets are buying everything”, BofAML’s Barnaby Martin writes, in his latest note, describing that rather poignant visual.
“All markets are roaring higher this year [as] 97% of assets across the globe have produced positive total returns”, he continues, adding that “not only is this a far cry from the paltry 13% of positive returning assets last year, but it’s as emphatic a rally as has been seen since 2009 – a time when markets were emerging from the GFC and when central banks were getting creative with stimulus.”
To what do investors owe their good fortune? Again, it’s policymakers – of the “monetary” variety. As we’ve noted on multiple occasions over the past couple of weeks, “lower for longer” is sooo passé – now it’s “lower forever.”
Martin reiterates this. “Markets now seem to be saying that it will be dovish central banks forever and ‘QE infinity'”, he goes on to write, before adding the only caveat that matters – namely that, eventually, folks will begin to ponder policy impotence. It’s just a matter of whether enough folks seriously consider foregoing carry to make “quantitative failure” trades viable.
Describing the YTD euphoria further, Martin warns that “for such market hubris to be sustained, we think central banks will ultimately need to overcome their own ‘red lines’ and keep inventing novel stimulus or else markets will remain vulnerable to the ‘quantitative failure’ narrative down the line.”
Right. And this comes back to a point we made while documenting one of Albert Edwards’ recent notes. After admitting that we’re probably a long way away from the Fed actually taking the NIRP plunge, Edwards reminded everyone that negative rates are “just one” of many controversial ideas floating around out there in anticipation of the next downturn.
Here’s what Albert had to say in February about MMT, the hottest of hot topics right now and something he promises to write more about later:
There has also been an increased flow of articles favourably disposed towards the controversial ideas of Modern Monetary Theory (essentially it is the idea that there is no government budget constraint when there is a sovereign central bank). I note that many of the more radical Democrats in the US seem to be adopting the idea and since I expect the US budget deficit to soar to 15% of GDP in the next recession, the ideas of MMT will surely become even more popular. I will write about that another time, but I certainly think the Fed and other central banks will be desperate enough to adopt outright monetisation (aka helicopter money, that is to say the direct central bank financing of public sector deficits) in the next recession. And as that will coincide with public sector deficits in the mid teens, we will be conducting a live MMT experiment. Welcome to a brave new world!
According to his own account, Albert had some conversations at Dylan Grice’s wedding that “advanced” his understanding of MMT, but the point is, with central banks bumping up against the theoretical “limits” of what they can do, and with politicians increasingly prone to abandoning pretensions to fiscal rectitude in a world where populism is still ascendant, ideas that previously seemed “radical” may well be seen as the “logical” progression of things in hindsight.
That’s something we’ve talked at length about and wouldn’t you know it, Barnaby Martin’s colleagues Ritesh Samadhiya and Ajay Kapur (who pens the bank’s “Inquirer” series that we’ve highlighted on occasion, including the “Please Reflate” SOS in late December), spell it all out in a note dated March 18.
There’s really no utility in trying to paraphrase this and because it’s pretty short and serves as but the intro to a longer note, we’ll just excerpt it verbatim as it’s pretty effective on its own and probably wouldn’t benefit from further editorializing. Again, this is by BofAML’s Ritesh Samadhiya and Ajay Kapur. To wit:
The world is becoming ‘financialized’. Asset markets are driving the global economies, not the other way around, a consequence of wealth and income inequality (plutonomy). There is no inflation, despite the herculean efforts of central bankers to achieve this. Historically inflation has been associated with young, low-debt, countries with income/wealth equality, some of which went to war with monetized fiscal deficits. Now most countries globally are the opposite – older population, indebted, unequal, and thankfully, free of major wars. With this deflationary backdrop, falling asset prices are very unlikely, and central banks blink quite easily, regardless of how “macho” they sound sometimes about tightening policy. In our view, such machismo should be faded. Since last August, we have argued that the world was in for a synchronized slowdown.
The rubber-band of the global economy is very stretched. We see a possibility of peak plutonomy, peak polarization, and potentially peak oligopoly leading to more unorthodox potential solutions being offered (eg, Modern Monetary Theory (MMT), 70% tax rates) in addition to anti-Buybacks, anti-oligopoly and anti-big Tech sentiment. In 1987, who would have expected the Soviet Union to collapse so soon, in 2007, who would have expected QE, in 2016 who knew Donald Trump would be US President? In all of these cases the experts/polls were wrong.
Bulgakov’s cat, Behemoth, played chess and took trams -the unthinkable often seems inevitable in hindsight: expect the unexpected in financial markets.
Oh, and nobody tell Jeff Gundlach about the (maybe) inevitability of MMT making its way into actual policy discussions – he’ll blow a gasket.