Trader: The Burden To Act Is On The Wrong People

Former fund manager-turned Bloomberg columnist Richard Breslow isn’t amused on Monday.

Specifically, Breslow’s first missive of the new week finds the irascible FX trader lamenting the current state of affairs in which global central banks are busy executing on a coordinated dovish pivot aimed at offsetting the drag from trade tensions, averting a downturn precipitated by politics gone awry and ensuring the bottom doesn’t fall out for financial assets along the way.

Breslow should have been a local politician. He’s got a knack for saying things that could fire up a small crowd and incite people to action. “There should be no comfort taken that a Fed president argued for a 50 basis point rate cut and wasn’t laughed out of the room”, he writes, an apparent reference to Neel Kashkari’s Friday blog post. (Cue the rousing cheers from the town hall meeting: “Yeah! He’s right!”)

“That 10-year Treasury yields are back down to current levels is a clear sign that the battle is being lost”, Breslow continues, on the way to saying what a “shame” it is that “it would probably take an oil shock that would adversely affect consumer lifestyles to perk up the spirits of central bankers who think it’s fun to contemplate how far below zero rates can go without doing any harm.” We said something similar to that on Sunday evening as follows:

It’s worth noting that while nobody wants World War III, a further rise in crude prices on the back of heightened tensions in the Mideast wouldn’t be the worst thing in the world for risk assets, considering falling inflation expectations are part and parcel of the bearish take on the global economy.

As is usually the case, Breslow’s observations are spot-on, but it’s not entirely clear there’s any utility in waking up everyday and sarcastically bemoaning a state of affairs that’s defined the financial universe for going on a decade. It just is what it is.

Breslow goes on to deliver a crowd-pleaser for the hard money blogs who will doubtlessly jump at the opportunity to generate 30,000 clicks by turning the following passage into some kind of over-the-top headline about “false markets”:

Continuing to respond to all difficulties through fiddling with short-term interest rates exposes the defining characteristic of our economic times: that financial conditions being kept at elevated levels is the primary way policy-makers validate their understanding of how well they are doing. Is there any other way of understanding who they think of as their constituency?

Duly noted, but there’s another side to this. Tightening financial conditions affect the real economy, which is why the Fed (for instance) ends up getting boxed in by market pricing. For instance, headed into the June FOMC, positioning in rates was so lopsided that had Powell deliberately pushed back against market expectations for rate cuts, he would have risked triggering a ghastly unwind in some of those trades, which could have quickly morphed into a tantrum-like scenario. That, in turn, could have tightened financial conditions rapidly, an outcome which, eventually, would spill over into the real economy.

For example, over the weekend Goldman expanded on their previous analysis documenting what a hawkish policy shock means for financial conditions. Without getting into the specifics, suffice to say the bank’s new estimate is that a 100bp hawkish policy shock translates to a 100bp FCI tightening impulse via a 7% decline in equity prices (35bp FCI contribution), an 80bp increase in long-term bond yields (a 35-40bp FCI contribution), a 40bp increase in IG corporate credit spreads (a 10-15bp FCI contribution) and a 2% appreciation in the trade-weighted dollar (a 10bp FCI contribution).

(Goldman)

That’s not a disaster, but it’s not trivial either. A 7% decline in equity prices means the vaunted “wealth effect” goes into reverse to the presumed detriment of consumer spending, widening credit spreads are perilous at a time when the corporate sector is, by some accounts anyway, dangerously over-leveraged and a stronger dollar tied to hawkish US monetary policy is a veritable killer at a time when global trade is imperiled by protectionism.

The point being, central banks are not only concerned with propping up financial asset prices and if they are, that obsession is at least partially down to the fact that, eventually, adverse reactions in financial assets feed back into the real economy.

Needless to say, the more crowded rate cut bets are, the more scope there is for a sloppy unwind on any hawkish surprise. The sloppier the unwind, the more likely a tantrum-like tightening of financial conditions becomes.

Of course, an acute tightening of financial conditions would end up forcing the same dovish outcome anyway, which means policymakers have to ask themselves what the point is in making one final heroic stand to push back on rate cut expectations, only to come back a month later and cut rates after stocks have plunged and credit spreads have blown out. And that’s to say nothing of everything Trump will have tweeted between now and the July Fed meeting.

To be fair, Breslow touches on that latter point explicitly. “Efforts are being made to lower market expectations for the outcome of trade talks at the G-20 meeting. That’s a shame”, he says, adding that “rate cuts are worse than an inadequate substitute for real progress. They put the burden of responsibility to act on the wrong people.”

Amen to that.