Chasing Your Own Tail And ‘Zombies At Dawn’

Over the weekend, we highlighted our “zombie dynamics” flow chart again.

It’s an important visual more for what it says about the possibility that post-crisis monetary policy has an embedded self-defeating mechanism than for the extent to which it can be used as fodder for endless lamentations about the end of creative destruction.

When you drive rates into the floor on safe-havens, you by definition herd investors into riskier assets, which is a nice way to get capital flowing when things have a seized up (it’s also a good way to inflate financial assets, in the hope of triggering the vaunted “wealth effect”).  But it can be counterproductive for policymakers if it prevents misallocated capital from being purged and thereby facilitates disinflation by encouraging overcapacity.

While the click-grabbing headlines center around the misallocated capital bit (and the forestalling of creative destruction), those are actually ancillary points from the perspective of policy. It’s the read-through for excess capacity and thereby for disinflation that matters if you’re a policymaker.

Sure, you want to avoid financial bubbles, but there’s a sense in which suppressing default rates and driving up asset prices is precisely the point. That’s a good thing until it all comes tumbling down, at which juncture you have to inflate a bubble big enough to subsume the last one.

What you don’t want, though, is for that exercise in deliberate bubble-blowing to end up creating disinflationary dynamics, because then you’re chasing your own tail, as illustrated above.

As a way of welcoming Christine Lagarde to the party – she takes the reins from Mario Draghi this week – we thought we’d highlight two charts from BofA’s Barnaby Martin.

The bad news is, “zombies” ares proliferating again in Europe.

(BofA)

“‘Zombie’ companies in Europe are heading higher again, after hitting a local low in mid ’18”, Martin writes, in a note dated late last week. “The risk with persistently easy monetary policy is that less profitable companies can refinance and give themselves time to keep going”, he adds.

The “good” news is that creative destruction isn’t dead yet. The number of distressed bonds in Europe is actually rising despite the explosion in negative-yielding debt:

(BofA)

“The irony in today’s world is that despite trillions of negative yielding bonds globally, the distressed ratio in European HY keeps heading higher”, Martin goes on to say. In fact, he writes, “the number of HY bonds yielding above 10% is at the highest since mid ’16”.

Price discovery lives – even as zombies make a comeback.