“The message from a string of BIS [Bank of International Settlements] reports is that the US dollar
is both the barometer and agent of global risk appetite and credit leverage.
Episodes of dollar weakness – such as this year – flush the world with liquidity and
nourish asset booms. When the dollar strengthens, it becomes a headwind for stock markets and credit.”
– Ambrose Evans-Pritchard
The US Federal Reserve and fellow central banks can be forgiven for telling us a white lie: nothing would be gained from admitting that they do not know how to extricate the world safely from their extreme monetary experiment.
Fed chair Janet Yellen has finally pulled one major trigger after countless retreats. The long-awaited reversal of quantitative easing will kick off in October.
Deutsche Bank calls it the start of the ‘Great Central Bank Unwind,’ candidate ‘Number One’ for the world’s next financial crisis.
The puzzle is why the Yellen Fed – usually so cautious – has chosen to enter these treacherous waters when there is no strict need to do so and before it has raised interest rates to minimum safe levels. This tightening sequence makes no sense.
Ambrose Evans-Pritchard is the International Business Editor of The Telegraph. He has covered world politics and economics for 30 years. Follow him. He’s good.
Fed day has passed and consensus is that the Fed is hawkish (pulling the punch bowl from the party by raising rates and reducing its balance sheet of assets purchased during QE). Yields around the globe moved higher, the 10-year Treasury note is trading back above 2.25%, the dollar rallied and remains slightly higher than prior to the Fed announcement. Gold sold off on the news and is testing its recent upside breakout.
U.S. equities weathered the news with the broad markets mostly unchanged and financials (beneficiaries of higher rates) rallied. International developed and emerging markets are slightly lower.
August and September are the two worst performing months for stocks each year. You wouldn’t know it from the relative calm in the market. From Bloomberg’s David Wilson, “This month’s pattern of calm for U.S. stocks persisted even after Federal Reserve officials laid out plans to begin selling some of the central bank’s bond holdings. The CBOE Volatility Index, or VIX, is headed for its lowest daily average in any September since calculations began in 1990. Wednesday’s 0.4-point decline in the VIX, to 9.78, as the Fed announced the monetary-policy shift.” The all-time low was in early 2007 at 9.39. Readings below 10 are rare.
Here is a look at the VIX Volatility Index since 1999. Imagine the calm confidence that set over the market in 2007. VIX measures perceived risk. We should get worried when everyone is comfortable and see opportunity when others are in fear.
Where is the demand for equities coming from?
One strong answer is the central banks… With a nod toward “party on” the Bank of Japan (BOJ) voted to keep its current easy monetary policy unchanged by a vote of 8-1 (with the lone dissenter arguing for more aggressive easing). BOJ Governor Haruhiko Kuroda said that ETF purchases are still necessary to achieve the 2% inflation target by reducing equity risk premium. Print and buy… no concern of price or return… “Still necessary to achieve inflation…” One has to ask/wonder what the other side of this might look like. But when? For now, no “other side,” at least in Japan, is in sight. Their markets rallied on the Fed news.
I had a conversation with David Bianco of Deutsche Asset Management in early August at Camp Kotok in Maine. He made a strong argument that we really should be keeping our eyes on the European Central Bank. It is that liquidity that is finding its way into global equity markets, including the U.S. Perhaps he is on to something.
Here’s what I mean…. When Draghi’s European Central Bank (ECB) creates money and buys bonds, the seller of those bonds is flush with new cash and needs to next decide what to buy. That money finds its way to something and I contend it is bidding up stock prices.
Bank of America’s Michael Hartnett is saying the same thing. He noted in a recent post that the Fed is not the world’s sole central bank. We have to consider the liquidity created by the ECB, the BOJ, the Bank of England (BOE) and the People’s Bank of China (PBOC). Hartnett notes that central banks have purchased nearly $2 trillion of financial assets year to date.
That is almost as much as the Fed purchased under QE1 during the crisis period in the early innings of the “Great Recession.” Today, there is clearly no sign of even a mild recession, yet the love keeps on coming.
Bottom line: Those foreign central bank purchases translate to a vast sea of liquidity supporting stocks. Hartnett calls it the “supernova of liquidity” and “the flow that conquers all.” My motivation and title for today’s piece.
Stocks are hitting new all-time highs in both the U.S. and globally, seemingly absent any concern about the gap in fundamentals, the age of the business cycle or the geopolitical risks that seem to be sitting on a knife’s edge.
And I think it’s gonna be a long long time
‘Till touch down brings me round again to find
I’m not the man they think I am at home
Oh no no no I’m a rocket man
Rocket man burning out his fuse up here alone
– Elton John, “Rocket Man”
Yet more buyers than sellers is what it is and, at the end of the day, it is what moves prices. Our trend models remain bullish on equities, our tactical models are long risk assets and our fixed income trend signals still bullish.
I’ve long posted a Don’t Fight the Fed and Tape (Trend) chart in Trade Signals and it’s remained bullish despite the Fed hikes since December 2015. But we should be mindful of the liquidity coming from other central banks because that capital does find its way here.
To that end, the BOJ remains all in, game on, the Bank of England just completed its QE program in the spring. The ECB has indicated it will begin to taper and the Fed begins its tapering journey next month.
Look, my view is that the significant risk we face is a coming “Sovereign Debt Crisis.” The seminal issue is we sit at the end-stage of a long-term debt super cycle and a reset is likely. Europe is a possible ground zero due to the size of debt, lack of common debt and challenged political union from north to south. China is a possible ground zero, as are the emerging markets you’ll find listed below in the body of OMR.
And just to make it a little more interesting, S&P downgraded China’s sovereign debt citing rising “economic and financial risks.”
But wait, there’s more: According the to the Bank of International Settlements (BIS), what was believed