‘Policy Failure Is Here’ (Just Give Me The Medicine)

Can you drown a virus in liquidity? Or, can you subject a biological threat to death by a thousand rate cuts?

Those are objectively silly, rhetorical questions. But we’re implicitly asking them right now.

Because, in a world where central banks have been the only game in town for a decade, and in the face of recalcitrant politicians who are reluctant to unleash fiscal stimulus for fear of raising the ire of whichever Olympian deity hurls lightning bolts at governments that spill red ink, all we’ve got to lean on in a crisis are rate cuts and liquidity tsunamis.

The visual speaks for itself. It’s simple, yet poignant. We’re starting from (basically) zero and, in the case of the ECB and the BOJ, below zero.

Even if rate cuts were a traditional cure for deadly respiratory infections, we’d be short on elixir.

Of course, when you have a virus, the doctor doesn’t generally prescribe rate cuts, and she doesn’t usually offer to make you more liquid by temporarily depositing cash in your bank account for any collateral you might post either.

You laugh, but that’s what we’re doing. The RBA, the Fed and the BOC all cut rates last week (here, here and here), and the BOJ conducted unscheduled repos. And there’s more where that came from, you can be absolutely sure of it.

Unfortunately, this comes hot on the heels of a year during which the net easing impulse (measured by the net number of rate cuts across the globe) was the strongest in years.

So, just as the global economy was wholly unprepared to absorb the shock from the coronavirus outbreak by virtue of suffering through a year (2019) characterized by the slowest growth since the crisis (and the first contraction in global trade volumes since the GFC), so too are central banks ill-prepared to cope with another demand shock.

And yet, they’ll try, if only because they must.

The ECB may not cut at the March meeting, but the market is looking for more from the Fed almost immediately. Stress in dollar-funding markets may force some kind of additional measures.

“Notwithstanding the slowdown in growth that we forecast we do not expect the ECB to cut interest rates yet”, Nomura said late last week, adding that “many ECB members will be reluctant to cut rates by another 10bp at the March meeting”. The bank instead suggests the GC will likely try to provide more targeted stimulus and attempt to prod Germany into fiscal action first.

On the Fed, Nomura is looking for 25bps more in March and another 25 in April. And that’s just the base case. In the “severe” case, we’re back to zero with possible forward guidance tweaks and QE proper.

(Nomura)

Deutsche Bank sees a total of 100bps of Fed cuts (including last week’s move). “We expect the ECB to react initially with a targeted policy (e.g., a special LTRO to support SMEs in affected regions, complemented by easy collateral rules and flexibility on NPLs) and we also expect the ECB to cut the deposit rate by 10bp to -0.60%”, the bank says, noting that the move would be “contentious”. As for the PBoC, Deutsche sees another 40 to 50bps cut to the MLF rate (which would, of course, pave the way for lower LPR fixings).

Ultimately, though, Deutsche’s George Saravelos raised the specter of policy failure in a separate note out Friday. In fact, he suggested that “policy failure is here”. To wit, from the note:

We disagree with central bank pronouncements that there is room to fight the crisis. Just yesterday the new Bank of England governor argued that the bank has 200-250bps of policy space. The Fed argues they have even more. But yields are approaching zero, where do they see it? If the price of money can’t go down the only thing to do is print more. But from Japan to Switzerland we have seen that switching one zero yielding asset (bonds) for another (cash) makes no difference. The market is rightly pricing policy failure as evidenced by the collapse in yields and inflation breakevens everywhere.

Needless to say, the likely plunge in crude prices engendered by the coming price war kicked off by Saudi Arabia over the weekend isn’t going to do anything to support inflation expectations, even as lower fuel prices are, ostensibly, a boon to consumers (although that won’t matter if nobody is allowed to drive due to virus lockdowns and quarantines).

In any case, the world is in trouble. And at this point, even if rate cuts and liquidity injections were just what the doctor ordered, the pharmacy is just about out of medicine.