“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.”