Do You Remember Snow?

We keep talking about monetary policy normalization as if it’s “a thing.” As if it’s feasible. As if it’s an option. I’ve repeatedly suggested it isn’t.

The drug addiction metaphor for monetary accommodation (and especially QE) is overused to the point of being a cliché. But whereas most clichéd metaphors lose their potency over time by virtue of becoming too ubiquitous, the characterization of the market as an addict seems to become more apt all the time.

Each new iteration of stimulus begets some new distortion, and each instance of stimulus withdrawal is met with some shudder somewhere, thus enhancing the explanatory power of a joke that otherwise might have died from overuse years ago.

Whether the recent move higher in global bond yields counts as a “tantrum” or not, we can trace it to the day after the September FOMC meeting. One way or another, the combination of a slightly hawkish dot plot shift, a slightly accelerated taper timeline (i.e., Jerome Powell’s remark that the taper could be completed by the end of next summer), a rate hike from Norway and, perhaps most importantly, a hawkish BOE statement, contributed to higher yields. A hodgepodge of macro catalysts (e.g., Evergrande and a burgeoning global energy crisis) then conspired with a post-OpEx landscape conducive to larger swings in equities to facilitate the first meaningful pullback in stocks since March.

It’s all quite fragile, and speaks to the pitfalls inherent in efforts to wean the market off stimulus. At the same time, market participants have come to expect policymaker intervention at the first sign of trouble. Time and again, central banks oblige, either with actual policy shifts or, more often, allusions to additional stimulus. The BOJ parrots a soundbite about being ready to “add more easing without hesitation” at least once per month. That, in turn, feeds the dip-buying mentality and reinforces instinctual vol-selling.

“Vol is definitely lower than it used to be. We have learned to accept this as the facts of life in the last decade,” Deutsche Bank’s Aleksandar Kocic wrote, in his latest, out Friday.

You’ll recall that Kocic, years ago, posited a permanent (or semi-permanent) “state of exception,” whereby the kind of martial law instituted by central banks in the wake of the financial crisis is never really lifted. He alluded to that in a Friday note.

“After the initial spikes at the peak of the 2008 GFC, vol has not only been trending lower, but each bounce back from the local lows has been countered with a progressively stronger attenuating force despite the fact that we have been facing shocks of increasing intensity and higher complexity while the stakes continued to rise at the same time,” he said, adding that,

We see this pattern of volatility as a consequence of structural changes of the rates manifold, different monetary policy, and a gradual transition to fully administered markets over the last decade. The stakes have increased so much that monetary policy can no longer leave the markets to sort it out on their own. In such an environment, there is progressively less reason for volatility both to get excited and to sustain its bid.

There it is again. A permanent state of exception in this context simply means administered asset prices. A dozen years of stimulus has pushed assets so far away from market clearing prices that we can no longer say (with any degree of certainty anyway) what those prices might be. For some assets (think periphery EGBs) we have no idea at all, if we’re being honest.

As discussed at length in “No Way Out Of This Rabbit Hole,” “The Lollipop Emoji” and “Too Far Gone,” it’s easy enough to say things like “Well, central banks should just ‘rip off the Band-Aid’.” But just remember that those Band-Aids don’t cover paper cuts — they cover bullet wounds. Rip them off, and some assets are going to bleed out on the pavement because no one knows what fair value is. It doesn’t help that some of the folks trading them were 12 years old when Lehman was designated sacrificial lamb.

There’s no going back to the way things used to be. It isn’t possible and even if it were, each passing year brings still more people into the fray who quite literally don’t remember what price discovery looks like.

When you think about this, consider that just this week, sources said the ECB is studying a plan to launch a new bond-buying program once the pandemic QE facility is wound down. Note that the pandemic program runs alongside “regular” QE. As Bloomberg tried to explain, the new plan would aim to “prevent any market turmoil when emergency purchases get phased out next year [and] would replace the existing crisis tool.”

So, PEPP would just get a few tweaks and a new name. And the ECB would keep running two QE programs simultaneously.

The same linked article said that “such an initiative would act as an insurance measure in case the scheduled end in March of PEPP prompts a market selloff of bonds from highly indebted countries such as Italy.”

That’s precisely (almost to the letter) what I said nearly a year ago in “Yen And The Art Of Bridge Maintenance.” It will never again be possible to allow the market to determine the price of certain assets. I used Italian debt as a case in point.

Another decade of this and a sizable percentage of Wall Street will only know real price discovery by way of anecdotes passed down by an older generation of traders. By 2040, almost nobody on Wall Street will remember. Like children born after a climate apocalypse, they’ll have to ask a grandparent what snow was like.