“Well, Fed printing is the greatest macro case for buying”, one member of the Twitterati remarked on Thursday afternoon, in response to my suggestion that it’s becoming increasingly difficult to make the macro case for staying constructive on equities after this week’s surge.
It’s true. That person is correct. If we’ve learned anything post-crisis, it’s that liquidity-driven markets are damn near impossible to trip up.
And, as I reminded that well-meaning netizen, I said as much on Thursday afternoon. To wit (and regulars know I relish opportunities to quote myself, despite how poorly that reflects on my character):
Everyone is quoting Citi’s Tobias Levkovich on Thursday. “Pretty much every client we talk to wants to buy the dip”, he wrote. “And that is not comforting”.
I don’t think that’s the right way to frame things. It’s not the classical conditioning that’s disconcerting. After all, who can argue with liquidity provision and what now seems like another date with the zero lower bound?
There may well be plenty that’s irrational about the policies, but as long as the economy doesn’t appear poised to fall off a cliff, there’s nothing irrational about being bullish when liquidity is abundant and rates are falling.
So, the problem isn’t so much that folks want to buy the dip. They’re backstopped – or at least they feel like they are.
What, then, is the problem? Well, the issue is pretty simple as I see it. The global economy had barely begun to inflect when the Wuhan epidemic came calling.
So, to the extent the largest easing impulse in recent memory (and by that I mean the net number of rate cuts delivered by central banks globally in 2019) was set to conspire with the good vibes from the signing of the “Phase One” trade deal and renewed balance sheet expansion by the Fed and the ECB to deliver a reflationary shock to the global economy, it’s all been upended by something of a black swan out of China.
C’est la vie. You know what they say about the best-laid plans of mice, men and macro mavens.
There’s little question that developed market central banks can, if they really want to push the envelope, drive financial asset prices higher still. Being “low on ammo” is not the same thing as being fresh out of bullets. There’s still scope for things to get “weirder”, even as it’s already pretty damn weird out there. Recall that last August, when bond yields were busy plunging to ever lower lows, markets witnessed the ultimate expression of NIRP-ian™ insanity: Negative-yielding high yield bonds. “10 Euro-denominated high-yield bonds now yield below zero, a mixture of both callables and bullets”, BofA wrote, at the time.
The recent bond rally has seen the global stock of negative-yielding debt balloon back out to nearly $14 trillion. While still well off the August highs, you should note that the total rose by $2.7 trillion in the space of two weeks through last Friday.
This is a function of a reenergized safe-haven bid catalyzed by virus jitters, and it’s compounded by the fact that this particular risk-off catalyst poses a clear, present and, most importantly, pseudo-quantifiable danger to the global economy.
This could scarcely come at a worse time for monetary policy, and DM monetary policy in particular. Having just fired several of their few remaining bullets, the Fed and the ECB are now staring down a situation where they may be forced to totally exhaust their countercyclical capacity in order to offset the drag from the burgeoning pandemic.
All else equal (and assuming more rate cuts and more asset purchases are still some semblance of effective at cushioning the blow from this latest shock), firing those last bullets will likely provide one final, liquidity-driven fillip to risk assets.
Writing Thursday on the linkages between DM central bank asset purchases and capital flows to Asia, Nomura’s Rob Subbaraman and Rebecca Wang reminded folks that QE works through portfolio rebalancing. “As G4 central banks buy more government debt, private investors are forced out on the risk curve, including into higher-yielding EM assets”, they noted.
As a reminder, 2020 is expected to mark the first time since 2016 that the net supply of safe-haven bonds available to private investors will fall. According to estimates from TD (which looked at Japan, the UK, Europe, the US, Canada and Australia), the global net supply of government bonds will drop 40% in the new year versus 2019.
All of this is conducive to further upside for equities, credit and, really, everything that benefits from abundant liquidity and the familiar scramble out the risk curve and down the quality ladder.
And yet, as BofA’s Hans Mikkelsen wrote nearly a year ago, “Communicating dovishness is always tricky as there is a delicate balance between the benefit of stimulus and the underlying driver, which is economic weakness”. Past a certain point, the rationale for rate cuts and asset purchases can overwhelm the bullish read-through for risk assets.
The threshold for that (i.e., the point beyond which investors focus on why central banks are cutting rates and expanding the balance sheet, as opposed to narrowly obsessing over how those policies may benefit asset prices) is high – it would likely take a recession before market participants would lose their appetite for front-running assumed liquidity-driven gains. The coronavirus isn’t likely to cause a global recession, so perhaps the Twitter follower mentioned here at the outset is correct. Maybe it’s best to just think of central banks as the only macro catalyst that matters.
But the larger question in all of the above is this: At what point do developed markets which can borrow for nothing (or next to nothing) and are not just struggling to bring inflation to target, but in fact conducting no-stones-unturned policy reviews in a panicked effort to stave off Japanification, decide to end this absurd charade and try something different?
All we’re doing at this point is plunging further and further down the monetary rabbit hole in a futile effort to engineer more robust real economic outcomes, with the inevitable side effect being inflated prices for the financial assets concentrated in the hands of the wealthy.
This isn’t going to work. For all the criticism of Keynesian policy prescriptions, the stone, cold reality is that strict Austrian “solutions” are not “solutions” at all. “Let it all burn so we can rebuild it from the ground up in the proper proportions” isn’t an option.
And, with apologies to everyone who will be rankled by this, decades of on-again, off-again Friedmanism have met with, at best, mixed results. At worst, Friedman can be partially blamed for a laundry list of unfortunate economic outcomes, ranging from the trivial to the catastrophic.
It is (past) time for a fiscal solution that recognizes the reality unfolding right in front of us.