On February 1, we gingerly suggested that market participants were witnessing something important – a policy shift that would have dramatic ramifications for all assets and would likely be seen, in hindsight, as momentous. Specifically, we said this:
In hindsight, January may well be remembered as the month when monetary policy makers ushered in a new central bank “put”, and if the history books do end up reflecting that, it will more than a little ironic.
After all, as late as December’s Fed and ECB meetings, Jerome Powell and Mario Draghi were emphasizing “auto-pilot” on balance sheet runoff and confirming an end to net asset purchases, respectively. That, against a backdrop of weaker data stateside and a quickly deteriorating situation across the pond in Europe.
Fast forward five months and that assessment looks prescient. The Fed is set to cut rates at the end of the month and most expect a new easing package of some kind from the ECB in September.
One of the primary reasons monetary policymakers have been forced to pivot so dramatically dovish is that politicians continue to exhibit an unnerving penchant for brinksmanship and the populist fervor that swept across western democracies in 2015 refuses to abate.
Despite ongoing political tumult, risk assets of all stripes have surged in 2019 thanks almost entirely to the new policymaker put we teased on February 1.
What you’re seeing in the coordinated dovish pivot from central banks is policymakers attempting to safeguard the stability they’ve spent years fostering against incessant threats from the political arena, be it Brexit, Trump, Matteo Salvini, rising tensions in the Mideast, protests in Hong Kong, the recent spat between Tokyo and Seoul, and on, and on.
One of the reasons central banks have been unable to normalize is down to the addiction liability they’re running, manifested in record duration risk and the proliferation of various short vol. expressions which are all subject to being unwound. As we saw in 2018, it doesn’t take much in the way of Fed recalcitrance (read: persistent hawkishness) to trigger a mini-emerging market meltdown, for instance.
The stimulus addiction aside, another reason central banks can’t normalize is simply that politicians continue to foster instability and uncertainty and it’s only recently that fiscal stimulus is back en vogue.
As BofA writes in a note dated Friday, revisiting the familiar disconnect between what the bank has called “politicians’ implied vol.” (proxied by US and China economic policy uncertainty indices) and “central banks’ implied vol.” (rates vol. in the US and Europe), “forward guidance, yield targeting, rate cuts and potentially more QE have all played a role in the recent melt-up across risk assets” which is “unfolding before our eyes despite still-simmering trade wars and the rising risk of a global economic slowdown”. The following chart will be familiar to some readers:
The bank goes on to underscore the notion that politicians are undermining what monetary policy has worked so hard to achieve in the post-crisis era.
“Central banks have managed to achieve record-low monetary policy uncertainty while politicians have pushed global economic policy uncertainty to record highs”, the bank’s Ioannis Angelakis notes, adding that “once again, central banks are trying to safeguard the economic outlook while politics threaten to derail the achievements of years of accommodative policies across the globe”.
The really telling chart is the following scatterplot, which illustrates how the last decade represents a sea change compared to the pre-crisis years.
As Angelakis goes on to say, describing the chart, “before the GFC, risk-assets were much more sensitive to political uncertainty [while] nowadays market trends are almost immune as central banks have shown that they can pivot back to dovishness very quickly”.
While that’s certainly true, the problem is that monetary policymakers are now woefully short on ammo. “Developed market central banks appear to have much less in the way of wiggle room” than their EM counterparts, Angelakis’ colleague Barnaby Martin wrote, in a separate note out Thursday. “The BoJ and SNB, for instance, both have balance sheets in excess of their domestic GDP and while the ECB balance sheet is only at ~40% of Eurozone GDP currently, interest rates are nonetheless at -40bp”, he continued.
Of course, some think Donald Trump has a plan – that the “method to his madness” involves creating so much uncertainty and political friction that the Fed is forced to cut rates and restart QE.
One wonders how he’ll take the news when, during his fourth term, with US rates in negative territory, 10-year Treasury yields at negative 60bps and SOMA bloated, Fed chair Jim Bullard tells him there’s nothing else that monetary policy can do.