What are Central Banks Attempting to Achieve at This Point?
Over the past two weeks, we have seen major central banks loosen the reins on monetary policy or otherwise set the stage to move further into unorthodox policies. The most notable moves were made by the European Central Bank (ECB) and Federal Reserve. The latter cut its benchmark by 25 basis points to bring its range down to a high level of 2.00 percent – though it maintained its increasingly dubious position that it expects no further reductions this year. The former took more dramatic action. The 10 bp rate cut lowered its deposit rate to -0.50 percent, but it was the announcement that stimulus purchases (QE) would restart in November after an 11 month hiatus and introduction to tiered rates to help European banks struggling with profitability that represented a shifting frontier for policy. Just as extraordinary was the steady course held by the Bank of Japan (BOJ) who maintained its open-ended stimulus program tied to a 0% 10-year JGB yield target and the Swiss National Bank’s -0.75% benchmark.
These four central banks alone could represent the landscape of global policy directing growth and inflation in the developed world, and that recognition itself should raise concern over the state of our economy and markets. An obvious question that should be raised in the face of this concerted easing is: what is the purpose? For all of the aforementioned groups, the target is either inflation and/or a growth metric like employment. It is reasonable to further assume there are certain unofficial objectives as well, such as general financial stability or even capital market appreciation as a means to fund a ‘trickle down wealth effect’ (something former Fed Chairman Bernanke was an ancillary objective of the US QE program). Yet, if we gauge the Fed against these various goals, we find core inflation above target, full U3 employment, volatility readings remarkably tame and capital markets at record highs. Why supply more fuel if you are already running at full speed unless you foresee a high probability of some crisis? Admitting this level of concern on the other hand could inadvertently trigger the conditions that realizes those fears.
Many feel the hazy objectives shouldn’t matter so long as the potential results are faster growth and/or higher local markets. Yet, that is ignoring the reality of the costs associated to such efforts, and there is more recognition of this cost/benefit reality being voiced among the central banks’ ranks. Adding to the familiar criticism from the BIS, we have had officials from the Fed, ECB, BOJ, BOC, and many others voice concern over our inflated and distorted foundation. Just this past week, Rosengren added to the discussion after he dissented the rate cut saying such efforts lead to inflated asset prices and encourage excessive leverage among household and businesses. An underappreciated consideration in this mix is the more general case that the ineffectiveness of monetary policy as a tool grows increasingly obvious. What happens should a genuine recession of financial seizure – not just a soft patch of unmoored fear of such an occurrence – shows? These banks will be one of the few options to squelch the fire and they will have expended their influence when it wasn’t even necessary.
Long-Term Versus Short-Term Objectives
There is a well-known business school debate that CEOs are incentivized to pursue short-term profits at the expense of long-term business growth – and sometimes continuity. This often leads to the ‘CEO is a villain’ caricature that that prevails outside the world of finance, but these objectives are pressured by a very different market force: investors. Market participants have long sought as much ‘share-holder value’ as possible when considering where to allocate their capital to fulfill a desire to outperform the broader market .That is aggressive even in the best of times, and it is particularly difficult nowadays. Another side effect of the extreme monetary policy being employed across the globe is a remarkably low rate of return on investments tied to benchmark rates (essentially everything). Meanwhile, the S&P 500 upon which performance is benchmarked is setting an impossible pace. How is a company to provide that level of ‘value’ when underlying growth is tepid? They borrow against the future like most other systemic players, such as issuing debt to buy back shares. And so, the system grows ever more unstable.
Another point of short-term focus arising on the horizon is found through government/fiscal objective. While there are certain countries that are shifting further towards long-term objectives – like China attempting to shift to service sector strength, consumer spending and open markets – the majority, particularly in the developed world, are heading in the opposite direction. That may be in part due to political cycles. Few places is this pressure more obvious than in the United States. The unfavorable polls for President Trump were easy to right off in previous years, but they are more difficult to overlook as the country starts to get into campaign gear. Just this past month, we have started to see a clear rise in concern over recession risks via investors and consumers in the United States. In a monthly economic Gallup poll, one of the reasons offered for the downturn in the outlook is the references to recession by economists – self-fulfilling prophecy. To stave off a leadership change in 2020, the Administration has very clearly fixed on the health of the economy as a critical target to boost reelection potential. Yet, they have also committed to the onerous trade war. How to offset a mature business cycle, a slower global economy and blowback from trade wars? Through the long-term, it is an improbable goal. For the short-term though, moves can be made to extend for a spell at the cost of greater instability and a deeper slump later on. This is why we are seeing demands for more central bank QE, fiscal policy that defies the typical party line and ruminations of devaluing the Dollar.
Recession Signals Rising Again
Fear over the health of the global economy continues to erode investor and consumer confidence. Sentiment surveys have stood as one of the most robust countermeasures against data that otherwise calls attention to struggling growth measures. Yet, even the most resilient of the economic participants are starting to show signs of wear. US consumers have maintained an almost unbreakable sense of enthusiasm until these past few months. That matches the sudden surge in search around ‘recession’ via Google – hitting the highest level since the Great Recession this past month. This shows a measure of awareness that will ‘weaponize’ poor data that gives weight to data that was previously overlooked. Testing this theory, last week, the OECD updated its growth forecasts and their perspective sent a chill into the market. With notable downgrades in 2019 and 2020 performance projections for the likes of the US, China, Europe and UK; they downgraded their global targets to 2.9 and 3.0 percent respectively. According to the previous IMF definition for global pacing, a reading under 3.0 percent could be construed a recession. The market didn’t tumble on the unfavorable update, but it certainly took the air out of speculative appetite in the aftermath of more central bank support.
In the week ahead, we should keep very close eye on the various cues for economic performance. There are sentiment surveys that are scheduled such as the US, Eurozone, German and UK consumer readings; and there will also be those measures that are often overlooked but made more important given the general perspective in the backdrop. The market readings will further keep markets occupied and perhaps return to main street influence. The US Treasury 10-year/3-month spread has neared zero and the 10-year/2-year spread flipped positive recently. Sometimes, a temporary relief can sharpen the recognition pain when it returns. If these figures worsen again, an already on-alert market will read into the turn. As for traditional data, Monday’s session carries the most direct vehicle in the form of September PMIs from Japan, the Eurozone and US.