There has been much teeth mashing regarding central bank unconventional monetary policy and the potential for a monetary devaluation amid forthcoming Fed rate hikes. Well known central bank critic Albert Edwards looks at the situation with his Societe Generale’s clients who, likewise, “Many clients we meet have similarly apocalyptic views to our own but remain fully invested. They cannot see an immediate trigger for the financial Armageddon that they accept is heading slowly our way.. .” No one can see the trigger for what Edwards describes as “financial Armageddon,” but they recognize it is coming, he writes in a December 7 report, . But might the trigger be found within China rather than developed world central banks?
Fed rate hikes: Stop coddling the markets, say analysts
When futures anthropologists dissect what happened to modern financial society circa 2018 AD, they might consider a November 16 Wall Street Journal column by James Mackintosh. Titled “The Fed is Poisoning the Market. Here’s the Antidote,” the article asserts that central banks should stop worrying about what the market thinks. Central bank policy should just be executed, interest rates risen, without forward guidance or primary concern for communications:
…the Fed doesn’t need to even issue a press release about it, let alone hold a press conference. Let the markets find out that the overnight borrowing rate has gone up when it, well, goes up. Such talk is heresy for the modern central banker, and markets would hate it. But that is the point. Central banks have been coddling investors for years with transparency and forward guidance, to such an extent that the question of what policymakers will do has primacy over analysis of inflation and the economy.
To Edwards, this sums up the current market conundrum.
Markets are riding a euphoric high the likes of which have never before been witnessed. While Edwards didn’t mention bitcoin specifically, he did point to the inflation of asset bubbles without regards to fundamental value as a concern.
“The current situation is even worse than in the run-up to the 2008 crisis,” Edwards opined. “At least back then rate hikes did not lead to easing financial conditions the way they do now! The Fed?s desire to soothe the nerves of the financial markets has made a mockery of their tightening cycle.”
Fed rate hikes: Stop the polite dance and get down to business
Edwards doesn’t think the Fed has even begun to tighten rates. Rather, what he sees is a tiptoeing around the problem of policy “normalization,” as if a world where bitcoin shoots through 16,000 and nuclear war with North Korea can ever be normal.
“Recent tightenings of monetary policy, whether by the Fed, ECB or Bank of England, were all perceived by markets as ‘dovish’ tightening and hence led to even more buoyant financial markets,” he wrote. “Policymakers are so scared the financial bubbles they created might burst that today what might be good for the economy is subservient to the needs of Wall Street.”
But does this delicate if not deft hand that Fed Chair Janet Yellen has displayed in raising rates without causing another “taper tantrum” deserving of some respect?
Bank of International Settlements Chief Economist Mario Borio, looking at reasonably dormant financial conditions analysis, doesn’t appear to be a fan of Yellen’s “gradualism” and “predictability.” During the 2000’s Fed policy tightening hardly caused financial conditions to budge.
Today's experience is reminiscent of the repeated reassurance of the 2000s' "measured pace", except that the adjustment has been, if anything, even more telegraphed. If gradualism comforts market participants that tighter policy will not derail the economy or upset asset markets, its predictability compresses risk premia. This can foster higher leverage and risk-taking. By the same token, any sense that central banks will not remain on the sidelines should market tensions arise simply reinforces those incentives. Against this backdrop, easier financial conditions look less surprising.
To Edwards, with his eye on the lookout for the trigger to financial problems, this gradualism appears to be like kissing your sister. “You don’t have to be a genius to reach the conclusion that central banks’ dovish tightening really means there has been no tightening of monetary policy at all for Wall Street,” he says. “But for Main Street, interest rate hikes do have an economic impact that will ultimately end in recession, and like an increasingly stretched elastic band this tension will eventually snap with disastrous financial market consequences.”
But those consequences might not arise out of developed world central banks, but first might appear in China. “It is the extrapolation of this period of calm in the Chinese economic and market conjuncture that might catch investors off guard,” he wrote. “For, inevitably, it is impossible to predict what might be the trigger to crash the global markets, but given the nature of these things it is highly likely to be something that investors are not currently worrying about, and China certainly fits that bill.”
Forget about bitcoin and the gates of hell appearing to open up in Los Angeles with wildfires. Keep an eye on China as well as central banks.