(In)credible Cold Turkey Moments

“Markets stop panicking when central banks start panicking.”

That’s a familiar refrain. It’s another way of saying beleaguered stocks and bonds, both of which are in a bear market, aren’t likely to stabilize until market participants believe policymakers are frightened enough to reinstate the vaunted “central bank put.”

But with inflation raging, orthodoxy demands rate hikes. Easing is anathema. The restoration of central bank “credibility” (note the scare quotes) depends on draconian policy tightening. It’s either victory or death for Jerome Powell and his global counterparts. Nothing in-between.

And so, markets are on their own. Or at least until the collateral damage is such that the risk of countenancing additional pain and volatility outweigh the risks associated with runaway price growth. That bar is very high in 2022, but the UK arguably cleared it this week, when the Bank of England was compelled to intervene in long-dated gilts to prevent a crash and a Lehman moment for the nation’s pension funds. Similarly, officials in Japan are panicking, as evidenced by the first yen intervention since 1998.

So, are we near the policymaker panic moment that could presage a durable turn in markets? Likely not, according to BofA’s Michael Hartnett.

Japan buying the yen and the BoE “flip[ping] from QT to QE” does “equal panic,” he wrote, in the latest installment of his popular weekly “Flow Show” series, “but neither is credible.” As discussed here at length this week, the BoE is conjuring new money to monetize debt while the government pursues unfunded tax cuts. That, Hartnett said, is inflationary. As for Japan, intervening to prop up the currency while simultaneously conjuring new yen to buy bonds (in order to preserve yield-curve control) is the very definition of “not credible.”

In addition to lacking credibility, there’s no sign of coordination. Nascent policy panics are thus “impotent,” Hartnett went on to write. In order for the Fed and the US Treasury to panic, the US needs to see a credit event, he added.

One way or another, a coordinated U-turn is probably inevitable, though. Or at least in my judgment. Going “cold turkey” (as Hartnett put it) off a dozen years of accommodation is almost guaranteed to kill a patient or two (or three or four).

Since August of last year, central banks have delivered 294 rate hikes, according to BofA, compared to 1,302 rate cuts since Lehman. At the same time, markets have seen more than $3 trillion in QT over just seven months. The figure (below) underscores the rapidity of the about-face.

That’s a severe shock. Central banks knew they’d fostered a potentially disastrous addiction liability. What they didn’t know was that an inflation crisis would compel a cold turkey moment.

“The rates and QT shock [is] hit[ting] Wall Street’s addiction to liquidity,” Hartnett remarked, noting that global stock and bond market cap has “collapsed $46.1 trillion since November.”

This week’s dramatic events in the UK were evidence that QT is perilous. All it takes is one misstep (in this case the announcement of unfunded tax cuts) to trigger a crisis. Remember: It was the juxtaposition between new gilt issuance to finance Liz Truss’s growth program and the BoE’s plans to actively sell gilts that triggered the collapse in UK bonds. That, in turn, set the stage for margin calls at pension funds.

“For decades now, bond vigilantes have been asleep on their sunbeds, lulled into a slumber by the soothing lapping of waves of secular stagnation and the froth of QE washing gently against the shore,” SocGen’s Albert Edwards wrote this week. “Now all that has been drowned out by the sound of gilts screaming in agony as the UK’s tortured public sector finances have awoken Rip Van Vigilante and he ain’t happy.”

“Despite the BoE’s actions being ‘idiosyncratic’ in light of the fiscal policy decisions of the new government, the fact is that QT has already broken markets,” Nomura’s Charlie McElligott said. “The BoE became the first central bank to ‘bend the knee’.”

Edwards echoed that sentiment. “As in 2018, QT is not ‘boring like watching paint dry,” he said. Markets “have forced the BoE into an ignominious Powell-like pivot.”

But, as BofA’s Hartnett suggested, the policymaker panic isn’t credible. Not yet, anyway. For that, you need the Fed. Edwards agrees. “This market riot won’t end until the Fed is forced to pivot,” he wrote.

All of this raises some rather amusing questions about the definition of “credible.”


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5 thoughts on “(In)credible Cold Turkey Moments

  1. “As for Japan, intervening to prop up the currency while simultaneously conjuring new yen to buy bonds (in order to preserve yield-curve control) is the very definition of “not credible.”

    It’s a form of “sterilized” intervention, done by many central banks since WW II. Not uncommon and not a sign of panic. This give with one hand, take with the other is simply a manifestation of central banks seeking to cling to their orthodox policy “rules”.

    Perhaps sterilized intervention is an outgrowth of treasury departments rather than central banks being in charge of intervention in most nations. (Including the US where the NY Fed carries out intervention on the behest of the Treasury Department.) So in this case it may signal a rift between the thinking and priorities of the MOF and BOJ.

    It is, however, a half-assed form of intervention.

  2. I guess what we are learning here is that NO central bank is truly credible. The Fed just happens to be more credible than any of the others are. For all the hand wringing over our national debt the past couple of decades, at this point, the dollar is the one currency to rule them all.

  3. “… with inflation raging, orthodoxy demands rate hikes … restoration of central bank ‘credibility’ … depends on draconian policy tightening. It’s either victory or death for Jerome Powell and his global counterparts.”

    I agree, but I have this terrible sense of foreboding stemming from the orthodoxy here. I feel like I’m watching a street gang initiation where the initiate, no matter how he feels, has to hurt somebody (actually, many somebodies) to earn his street cred and be invited to be part of the gang. Powell has been under attack from the leadership in two administrations and the Congress since he took over. He is searching for some cred. I just hate to think many millions will suffer great damage as a result of decisions that may not be the best alternatives. Volcker had to go to 20% to fix this before. Are we headed there? What if in the middle of all this Putin nukes all the reactors in the Ukrane and burns its crops? What will Powell do then?

  4. What if there are no good economic outcomes for the economy from continued debt monetization and QE? What if our global situation renders Central Bankers, who are responsible for ‘inflation control’, as somewhat impotent to solve this problem using only demand destruction from higher interest rates? And, what if the institution of Central Banking itself is at stake with uncontrolled inflation?

    Every one (me included) worries about a market liquidity event. They see Central Banking pivots as inevitable because higher interest rates will eventually kill the stock and housing markets. If nothing else, the dual mandate and ‘maximum employment’ will eventually call in the doves when the job market fails.

    If nothing else, they see as a non-starter the debt market imploding. If you don’t believe that the debt market doesn’t likely take precedent, just ask the U.S. Federal Government for their thoughts.

    However, inflation works for no one, especially Central Bankers. No where in the dual mandate does it say that price stability is not a foundational concept. That it is not the number one priority over jobs.

    I believe that at some point, Central Banks will manage interest rate hikes, QT and debt market liquidity events the best they can, then cut off Wall Street’s arm with a hacksaw to try and save the economy for the long term. This likely means draconian interest rate hikes above what people are expecting. For no other reason than they believe perpetual QE will only make the inflation problem worse.

    I believe this time, it is likely that Central Bankers are trying to save the institution of Central Banking itself.

    It might exist, but, with continued high inflation, I don’t see a good option that allows Central Bankers to kick the can down the road this time. Other than prayer.

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