With the Fed’s Language, Global Central Banks Signal Softening Policy
Global monetary policy has shifted more noticeably to the dovish extreme of the scale over the past months, but investors were overlooking this questionable support because the markets were under serious duress. Yet, after the three-month tumble leveled out into a meaningful recovery into January, market participants began to look for fundamental reasoning to justify their growing confidence for their exposure. With the Fed’s unmistakably dovish transition between the December and January policy meetings, conviction in central bank support started to return to levels that mirrored the zombie-like reach for yield that defined the low-volatility, steady climb assets between 2011 and 2015. The terms of ‘plunge protection team’ and ‘QE infinity’ as applied to the world’s largest central banks are frequently voiced as skepticism by those that think extreme accommodation is ineffective and far more costly than central banks and the average investor appreciates. However, those phrases are just as significant to the bulls who have grown to depend on group’s like the Fed to keep an artificial calm over the financial system.
There is good reason to believe the US central bank has taken a meaningful turn in its policy regime. The December Summary of Economic Projections (SEP) lowered the 2019 forecast for rate hikes, but last week’s rhetoric made clear that the water mark for even a single hike this year is likely beyond the reasonable threshold. The US central bank is only signaling a curb to future plans of rate hikes following 225 basis points of tightening, but that is arguably one of the biggest alterations of course that we’ve actually seen. There is little mistaking that the course is such that the comfort in slowly normalizing extreme policy easing has all but vanished amid slower growth, breaks in global trade and threats to financial stability. That will incur more concern amongst those in the markets than speculative opportunism. Benchmark risk assets are not trading at a value-based discount and our proximity to the extremes of traditional as well as unorthodox policy will curb hopes for the recharge for milestones like the S&P 500 to make it back to record highs – much less surpass them. Of far greater concern in monetary policy in my book is the consensus recognition among investors that central banks have no recourse to fend off a genuine crisis should the need arise. And, if we follow this path, the need will come.
Only the US central bank has any leeway to purposefully lower rates, and that is only 2 percentage points to return to zero where the economy would once again find itself stuck in a financial hole. Returning to active stimulus expansion will only lead down the same path that the Bank of Japan has already found itself lost upon. The BOJ is stuck tying bond purchases to its 10-year Japanese Government Bond yield with no sign of reliably faster growth or sustained pressure for inflation to return to its target. The lack of traction for Japan’s central bank already draws enough unwanted attention to the state of monetary policy. If similar acknowledgement of a permanently disabled tool spreads to global monetary policy, we will find no other probable means to stabilize a market crash or economic slump by officials’ means alone.
With Sentiment on the Upswing, Expectation Rise for Trade Wars
We have seen a few of the more pressing fundamental threats to the global order abate over the past few weeks. It comes as little surprise in turn that sentiment in the market has improved in tandem. A slow normalization of monetary policy was seen as a slow strangulation of stubbornly nascent growth. With the Fed, ECB and others signaling their submission to the rise of external risks and stalling economic measures; the leash on speculative excess has been let out a little. Another point of perceived improvement comes from the end of the US partial government shutdown the week before last. After a record-breaking, 35-day closure that cost the economy an estimated $11 billion – a hefty portion that will prove permanent – this large component of economic activity is once again contributing to expansion. Of course, there are a number of caveats associated to this situation that should leave traders uneasy such as: the threat that the shutdown could be reinstituted by the middle of this month; that the tangible impact on the economy may have pushed a tepid expansion into a stalled or contracting economy; as well as fostering a collapse in sentiment around a government incapable of finding critical progress when it may be most necessary (such as in the emergency of a crisis).
More generally, these improvements are notable the lifting of a fundamental burden imprudently applied to the system rather than a genuine upgrade to the outlook. How much growth and opportunity can we expect from the correction of errors? Well, at the moment; the answer to that question is: at least a little bit more. With these and a few lesser issues throttling back the burden, the markets will be monitoring for what other temporary boosters can earn a little further stretch. One of the most extensive threats to arise this past year with an explicit price tag attached to it has been the trade war. While there are multiple fronts to this effort to grow at the expense of trade, there is no skirmish more costly than the standoff between the United States and China. With tariffs on over $350 billion in products, we have seen sentiment and growth measures on both sides deteriorate. However, rhetoric surrounding the discussions between these two powerhouses has recently elicited more enthusiasm from officials and the market.
This past week’s discussions between the Chinese Vice Premier and a delegation of key people from the US (Trade Representative, Treasury Secretary, Commerce Secretary) was said to have gone well and that the conversations would continue in China shortly. Never mind that there were no tangible policies suggested nor that President Trump said he would likely keep to a tariffs hike at the end of the 90-day pause as of March 1st. With speculative assets on the rise and market participants believing that officials are doing what is necessary to foster buoyancy in benchmarks like the S&P 500 (speculation the Fed capitulated in the market slump while Congress and the President surrendered in order to avoid the negative weight), it stands to reason that the White House would divert its trade course to afford further gains. In the end, though, these will still be temporary gains.
How Important is this Week’s Bank of England Rate Decision?
When it comes to the British Pound the principal fundamental concern remains the uncertainty that Brexit poses to the UK economy and financial system. This is more troubling for investors – foreign and domestic – than something more targeted and acute like a stalled GDP reading. There is no doubt that a halt to growth is a problem, but the issue would be a known quantity. From the details provided with the general update, we would know where policy and support would need to be targeted to course correct into the future and investors could still identify opportunities from those areas of the economy which are still progressing or are likely to do so from a temporary discount. When we are dealing with a complex and unwieldy situation like the UK’s divorce from the EU with a distinct countdown (to March 29th) and the sides obstinately at odds with each other, it can be extremely difficult to confidently assess the risks of your exposure.
This same contrast will exist with the upcoming Bank of England (BOE) rate decision on Thursday. The central bank is very unlikely to change its key lending rate at this gathering and rates markets reflect that belief. However, this is one of the more nuanced gatherings with the inclusion of the Quarterly Inflation Report. The update includes pertinent information to assess the outlook for the economy and financial system – which Brits and investors are desperate for at the moment. Their growth assessment will no doubt reflect some of the troubled figures that we’ve seen via various timely sector updates. Further, acknowledgement of external risks and ongoing Brexit fallout (such as surveys showing businesses are actively looking to relocate or considering it) will be a central element to the update.
Yet, will it be market moving? Governor Carney and his crew have warned of the risks to a ‘no deal’ split for some time now, and we have seen the market’s reaction to their concerns drop steadily over time. It is the case that the Pound’s recent climb these past weeks poses as certain degree of premium that could be cut down by otherwise routine concerns. However, if I were to see a headline suggesting a breakthrough or overt block in the dialogue between Prime Minister May and her EU counterparts, I would expect it exert far greater influence over the Pound than what the BOE could reasonable do.