Regarding eternity, it is my conviction that nothing; not even love, hope, or faith, springs eternal. Neither does life. Thankfully, there is an expiration date for all of us. Emotions, hopes, and beliefs are, more frequently than not, faded at some point. To all appearances, our Central Bank deities are also impaired by this human weakness. The very same year the 1975’s have begun to sing about it, most Central Banker’s, discreetly and dispassionately, have, all of a sudden, had A change of heart. About time! As Unamuno (famous Spanish essayist) once stated, a man has the permanent right to contradict himself. Good to know that, because it might come in handy soon enough!
Following up on that sudden change of heart, please don’t make too much of it. It’s not an abandonment of their firm beliefs in Keynesian utopia, and it is circumscribed to some specific, but highly relevant, matters. Like…. Well, amazingly enough, it is related to the merits and efficacy of “nirping” and “printing” ourselves all the way to financial disaster.
Most Central Bankers had a nightmare this summer, and the Kalecki path to monetary destruction was clearly exposed to them in a dream. It was a MLK kind of dream, vivid and clear -they are now scared to death. Of late, I can see the fear in the whites of their eyes -as they inevitably question their deeply held faith that the Bernanke policy mix would save the world. Bad for them, but, I will concede, it comforts me deeply. Apparently, insanity, unlike stupidity, does have some limits after all.
Not that the dream couldn’t have come earlier. It was crystal clear to anybody who wanted to see what was going on. In fact, it took ages. To prove the assertion, I am reproducing three great charts, courtesy of Tad Rivelle at TCW, John Hussman, and Jeffrey Sneider. They all summarize what the FOMC members have done over the last 25+ years (Greenspan, Bernanke and Yellen tenure).
Take your time working on them. It is their simplicity that makes them so valuable. They are further explained at TCW’s, Hussman’s, and Alhambra’s websites. It is pretty obvious that there is no way to leave this party unscathed. To add insult to injury, the amount of global leverage (next chart) puts us, worldwide, in absolute terms, well past the Minsky moment. Stability, as he said, generates instability, as Ponzi debt takes over productive debt. At some point, leverage goes past the amount of income needed to service the debt. Then, the credit boom stalls and asset markets and the economy crash. Negative interest rates postpone this, but at the cost of suppressing productivity increases -because Schumpeterian creative destruction comes to a standstill. Hyman P. Minsky was a visionary. He saw, decades ago, what reality is only confirming right now.
The FED.- So maybe Yellen, Dudley, Tarullo, Fisher, Powell, and Brainard saw these charts, or maybe they did not. But you bet most of them (Brainard is a special Hillary related case) are now changing their mind on the best prospective route forward. Or they did, even before this, but they proficiently kept the matter to themselves.
Right or wrong (time will say), this is a new insight. I haven’t read anything up to now, about this subtle change of heart. The fact is, you can feel it but, if you want to prosper, you must not talk about such things happening to our economic Archbishops. And, of course, if I were important enough (I certainly am not), a change of heart would be promptly denied by various speakers.
A hint of that was explicit in the contrast between the words, and the body language, in Yellen’s press conference last Wednesday. She denied any change of heart, assuring that the economic recovery was just around the corner, and she was just waiting for some more inflation to lift rates (see how unfair it is that Pinocchio is who gets the credit for the best liar in history). Her underlying message was very different, and I think it was perceptible enough. They are now heading away from more easing, and Heli-money has become a taboo subject. I am confident I can phrase it accurately. What Yellen in fact meant (without saying) was:
“There wasn’t really much dissent at the meeting, despite the three negative votes (that’s literal). We would all like to raise rates you know, it’s just that some of us are petrified of a stock market hissy fit (in double talk: we want to make sure it’s the right time to do so). So we, the core members of the FOMC, decided to hold our ground and let others vote against. We would like to move as well, but our perception is that we are unable to turn the tide without a market disruption. We hate market tantrums.
Kalecki was right, lower rates beget lower rates in an endless vicious circle. We shouldn’t have gone this far Ben. We are now scared and want out of this asap. We came all the way believing it would be easy to opt out and … Now we find out it ain’t that easy!
We are aware of the increasingly perilous side effects of our policies -that are killing us (productivity sags, corporate leverage soars, pension fund and bank bankruptcy loom, excessive shelter cost spirals, car loan subprimes abound, bubbles of all kinds are stratospheric, and so on). But we can’t afford to provoke a market collapse on our watch. We are stuck, we, the glorious invincible Seventh Cavalry, are surrounded by angry Indians (market players, bank managers, savers, left outs…) who want to crash our cherished markets, and we are desperately looking for a way out.
Can’t find one! We would call Houston for some help with our problem, but, to make things worse, we are unable. Radio works fine, but we must not let others see our weakness here. We have to save face and tell them everything is awesome, and our toolkit is magnificent -or else they will charge us before we can escape.”
The BOJ.- I was unable to check the body language in Kuroda’s event. But, lacking word comprehension (my Japanese knowledge is, in Fed-speak, zero), and visual contact (I did not watch the press conference video), Mark Twain’s sage quote, “Action speaks louder than words”, helps me gauge a similar change of heart at the Japanese “Sancta Sanctorum” for monetary policy. Notwithstanding Kuroda’s brave words to cover the tracks of their cowardice, they plainly chickened out on more monetary easing (thank God).
But they can’t allow the market to think they are doubting the efficacy and side effects of their toolkit. So they came out with this new idiotic policy about shaping the yield curve. We can brand it with a new acronym: NTO (negative twist operation). Anyway, did I say they were just going to shape the yield curve appropriately? Come on, they are have been setting all the relevant prices in global asset markets for what seems an eternity. No news in that deal.
The real news is that they will try to put a stop to the spiral of more and more printing, with lower and lower rates. And, to prevent their banks and pension funds going under too fast, they will try to keep long-term rates above zero (I think that, in their double talk, a “zero target” must be read as much above zero as it may be possibly compatible with ZIRP and levitating stock prices). But what if I’m wrong and they meant exactly zero, instead of above zero? Are they willing to sell or buy ten-year JGB’s in unlimited quantities to keep the peg? Because that is indeed a peg. Now we use not only currency but bond pegs as well. Interesting times. They should ask Jordan and Danthine how that worked out for them at the SNB. Yes, the HKD peg is still working, I know, but that’s another story altogether.
The ECB lives in a world of its own. Their headquarters in Frankfurt are the current symbol of Babel’s tower. Draghi still boasts the efficacy of his policies. But when it comes to facts, we get sobering data to show -for all the monetary activism. Zero hedge is always somewhat biased about any news related to the establishment, but I liked this synthesis on the highlights of the ECB’s latest success. Six hundred billion in QE (with subtle debt mutualization included in the pack) and 31 billion of growth in GDP to show for it. Wow!
In the meantime, no reforms in the economic landscape to show -for all that money spent unwisely. German trade surplus remains at 10% of their GDP, effectively begging their neighbors, and others, big time. The very same neighbors that are in a chronic state of meager, if any, growth. A growth they desperately need to pay their debts. The South continues to be a colonial market for the German industry. Europe will not survive in its current form. I’ll bet the ranch on that.
I’d like to say the reactions at the board of the ECB, also show a clear change of heart. It would fit the title nicely. But I see only a tenuous, half-hearted, implicit admission, that more of the same might not be the way to go. Everybody in Europe was taking increased “nirping” and printing for granted. And then came September and the Powers that be said, no, or at least, not now. They deceived their supporters, but it’s hard to perceive a change of heart on just that negative action. Europe was the last continent to be seduced by monetary alchemy -and will probably be the last to realize that the alchemy was no better than Panoramix’s “potion magique”. A great story, that of Panoramix and friends, but considerably detached from reality.
The BOE.- Mark Carney would definitely not be my choice to chair the BOE. He is no better than Bernanke. He got the job most likely because of his Goldmanite affiliation -bypassing Paul Tucker. He is a bubble blower, but I have to say something for him. I don’t like the hand he has been dealt. He has to induce some sterling depreciation to help the UK’s Trade Balance, try to keep the economy moving forward in times of uncertainty, put a lid on unbridled asset inflation (Real Estate), and should be trying (he is not) to reestablish the concept of sound money (sound Sterling). And he has to do this in a country where entitlement rights assumed as a given by the population, run at higher levels than in some of the continental countries (like Germany and other members of the core). Not an easy feat. I don’t think he can have a change of heart anytime soon. He is 100% focused on keeping things working! Carney will stick to Keynesian orthodoxy for as long as it is accepted internationally. Talking figuratively, he will not break the buck. I am including two charts on two of the most relevant Carney headaches.
PBOC.- Not much to say about them. Where their heart lies doesn’t really matter, because of their external boss that does all the thinking. Did I say thinking? No, take thinking out, and make it “surviving”. The Chinese government is in “survival mode”. Thoughts, economic analysis, emotions, or beliefs, are also “taboo” for the foreseeable future.
Action speaks louder than words, Twain said, but he added, “not nearly as often”. Now is, beyond a shadow of a doubt, one of those sporadic moments. When viewing them all (All Central Banks), in the big picture, their latest August-September action is explicit enough. Regardless of the Fed-speak and related prose, that will try to fade their acts and talk up their endless love of ZIRP and QE. But make sure you do get their underlying message right. Read their lips:
- no more NIRP unless the boat is actually sinking,
- no more QE if we can help it, and
- looking forward to “normalizing” monetary policy asap (to a greater degree in the US).
Yes, in a time frame of less than two weeks the BOJ, The ECB, and the FOMC have exposed glimpses, and even pronounced some explicit wording, related to their ebbing faith in the nirvana to be achieved by further kicking the can down the road. All of a sudden Heli-money and more NIRP are not cool anymore. Of course, they insist they can be used, but they do so only as a way to demonstrate their power and the usefulness of their toolkit. But they’re only bargaining for time now. They want (have) to show they are still on top of the financial food chain or else…
Isn’t God merciful! He decided that we normal human beings should be given a break from Central Banking’s increasingly rigid, radical, Taliban way of thinking. With the Taliban out, all of a sudden, we can all laze in the sun without a burkini. Make sure you enjoy that, provided you don’t get sunburnt -as financial prices adjust to a new perceived limit in the previously considered unlimited CB printing and “nirping” policies.
Sorry that the good times of easy money are being left behind? Feeling melancholic? Don’t be. Lowering rates “ad infinitum” was not taking us anywhere. Kalecki briefed us on that outcome a long time ago. Surprisingly enough, some doubts are also popping up in our deity’s social chatter. Do they have a WhatsApp group chat as well? I don’t really care much. But, even if they never lift rates again before the global asset repricing, it is good news they evaluate where their tool box of unorthodox measures was taking us. An increasingly faster vortex -breaking up all asset market pricing logic that might be left.
After all, maybe we can go for the market repricing direct, without a previous Heli-money induced, hyper-inflationary outburst. The ECB two weeks ago, the BOJ last Wednesday, and the FOMC on that very same Wednesday showed some pragmatism. And they began to change the market player’s perception of a seemingly eternal spiral of more “nirping” and “printing”. Let´s not get overexcited about this though. They still plan to control the shape of the yield curve (BOJ explicitly says) and any other relevant financial or asset price they want to pervert (NY POMO desk). But they are drawing a line in the sand regarding helicopter money, and a Kaleckian spiral of progressive “nirping” in global bond markets. For the time being. Let’s see how long they can withstand the pressure of faltering prices in risky financial assets.
Brief investment overview.-
The main consequence of this change of heart is that the odds of the reflationary route to the financial repricing of assets have to be downgraded. Accordingly, we have to allocate a higher weighting to the deflationary bust scenario.
Bond duration (see chart) is a crowded, overextended trade, and still a dangerous risk to pick up, but we can give ourselves more leeway in that area. On the negative side, this reinforces the chances of a global equity repricing. I’ve been saying this for what seems an eternity -I know. But the probability of this scenario has increased markedly with this change of heart. Lastly, the strong USD scenario is now closer, even though CBs will put up a fight to keep a lid on the USD.
All the above is very tentative thinking, to be confirmed by events. But if we begin to move in that direction, I think this deflationary trade has a fair chance of delivering good money. That is, all other things being equal (“ceteris paribus”). On top of that, Marshallian methodology based, expectation, I see three risks of substantial importance -as possible catalysts for more sudden cataclysmic events.
1.- A CNY devaluation.- A game changer -if it takes place (after the 30th of September). China would export a new wave of deflation to the outer world -I am not sure we can handle it. This chart, produced by Albert Edwards, is slightly dated but illustrates the point. No need to elaborate further -this post is getting way too long.
Shorting the CNH makes lots of sense. Small downside, a most likely small upside, and an outside chance of making a killing in a key tail risk to the system. It is a very cheap put on systemic instability. I’m looking forward to increasing my size, relative to AUM when the time is ripe for it.
2.- Risk parity, and cumulative short volatility trades.- VIX ETFs have created a time ticking bomb while biasing “implied” volatility downward, duly aided by POMO desks suppression of market, “real”, volatility. Add the growth of risk parity strategies to that, in a context of brutal correlation of all assets, particularly stocks and bonds. Spice it up with a virtually close to zero level for risk spreads (see chart for unbelievable, negligible high yield spreads).What you get is an explosive cocktail, that a Taliban in search of 40 nice-looking virgins, would die for (pun intended). Better than the neutron bomb. Any market pullback above 5% put us in real danger. The system is as fragile as it has ever been.
3.- A garden variety recession.- I think we have one in the making. The US will lead the cycle. Europe will follow up -with a time lag.
- NIPA margins peaked in Q2 2014 in what has been my most prescient (but useless) call on this blog (see “mal pronóstico para los resultados empresariales” September 2014). At the time everybody thought profits were going up forever. Sorry for tooting my own horn, but I also need to generate some self-esteem.
- Capex growth is now negative for the last year. A no-brainer stat. at anticipating recessions. It does look as if it’s going to remain that way -for as long as this NIRP environment lasts.
- World trade, shipping, and rail figures look awful.
- The Fed’s labor market condition index is now negative for the first time since 2010.
- US Manufacturing looks … you say how it looks!
- The consumer was the last bastion of strength in the US economy. Check US retail sales in the chart below.
I ran out of time, and reasonable length limits, in this post. If one of those three events materializes, the bust will be violent, and the only wild card is a possible comeback of the now taboo concept of Heli-money. I doubt we will go for lower (more negative rates), significantly. A deflationary bust is now the dominant scenario. It can come in slow motion … or precipitously, depending on the catalyst.
Good luck to the rest of you traders. It ain’t easy to make money nowadays. Let’s take solace in the fact that it never was. And thanks for your reading!
You sure know who Karen Blixen is, don’t you? I love Mozart’s music score, the African landscape … and the story.
Isn’t it an irony of fate that Karen Blixen finally went bankrupt after a fire destroyed her coffee factory in Africa? The video is great. It makes you “fly” with them!