There’s no point crying over spilled milk, and all’s well that ends in 92% of global assets posting a gain in 2019, but central banks likely won’t forget the overarching lesson they learned last year.
That lesson: Weaning drug addicts off opioids is hard. You can kill the patient if you’re not careful.
We can all argue the “what ifs”, but by December of 2018, many of the folks who, just nine months previous, were still extolling the virtues of “plain-spoken” Jerome Powell and his non-academic approach to Fed communications, weren’t so sure anymore.
As stocks crumbled, credit spreads widened and the leveraged loan bubble showed signs of bursting, “plain English” fans were suddenly pining away for some of grandma Janet’s home cookin’.
As BofA’s Ioannis Angelakis puts it in the bank’s 2020 credit derivatives outlook, “last year’s experiment failed monumentally”.
“In late 2018, central banks turned too hawkish too fast”, he writes, adding that the combination of a “deteriorating macro backdrop… and a hawkish turn across a number of central banks” was too much for markets which, for the better part of a decade, had been pacified by policymakers’ implicit vol. selling.
The “bad” behavior that engendered has now made it virtually impossible to unwind the experiment.
“After years of record-low funding costs and trillions of QE money, global central banks sparked a debt super-cycle”, Angelakis notes. “Amid a rising pool of rate-sensitive assets, central banks have been held hostage by their own policies”.
The nascent cyclical rotation (and some folks are already writing the obituary on that) and early signs of a bottoming in some key data (e.g., the German manufacturing PMI) notwithstanding, the macro backdrop will not be in any shape to support sharply higher rates anytime soon. The green arrow in the visual is what counts as a “bounce” these days (the red circles suggest the manufacturing slump is starting to spill over to services with a lag).
Between that, and the likelihood of ongoing geopolitical and trade uncertainty, it will be incumbent on central banks to tamp down volatility and keep risk premia compressed, thereby perpetuating the disparity between market-based measures of volatility and news-based indicators of policy jitters and recession worries.
In short, “central banks will remain the largest sellers of vol in the market for another year”, BofA’s credit derivatives strategists wrote this week, noting that with “global economic policy and global trade uncertainty at all-time highs”, policymakers will be forced to “combat such a headwind [by] keeping rates and rates vol close to record lows, ultimately supporting risk taking”.
Central banks have proven quite adept at administering the “medicine”, but haven’t even begun to learn proper detoxing procedures.