More Not Less

As markets return from vacation
The central banks’ tales of inflation
Continue to stress
They want more, not less
Thus, policy ease is salvation

With the market back to full strength this morning, after a long holiday weekend throughout much of the world, it seems that every story is about the overall change in tone by most major central banks. That tone, of course, is now all about the end of the nascent tightening cycle. Whether considering the Swedish Riksbank, which saw disturbingly higher Unemployment data at the end of last week thus putting the kibosh on their efforts to continue policy normalization and raise rates back up to 0.0%, or the weekend WSJ story that hypothesized how the Fed was reconsidering their framework and trying to determine new lower thresholds for easing policy, all stories point to one thing, central banks have looked in the mirror and decided that they are not going to take the blame for the next recession.

This means that we need to be prepared to hear more about allowing the economy to run hot with higher inflation and lower unemployment than previously deemed prudent. We need to be prepared to hear more about macroprudential measures being used to prevent asset bubbles in the future. But most importantly, we need to be prepared for the fact that asset bubbles have already been inflated and the current monetary policy stance is simply going to help them expand further. (Of course, central banks have proven particularly inept at addressing market bubbles in the past, so the idea that they will suddenly be able to manage them going forward seems unlikely.)

Naturally, there are calls for a switch in the mix of policy initiatives around the G10 with demands for more fiscal stimulus offset by less monetary stimulus. That idea comes right from page one of the Keynesian handbook, but interestingly, when the US implemented that policy last year (tax cuts and four rate hikes) both sets of policymakers got lambasted by the press. Fiscal stimulus at the end of a long growth cycle was seen as crazy and unprecedented while Fed hawkishness was undermining the recovery. These were the themes portrayed throughout the press and the market. When considered in that context, it seems that pundits really don’t care what happens, they simply want to be able to complain about the current policy and seem smart! At any rate, it has become abundantly clear that neither fiscal nor monetary policy is going to tighten anytime soon.

So, what does this mean for markets?

For equity markets, the world is looking incredibly bright. Despite the fact that equity markets have rebounded sharply already this year, (S&P +16%, DAX +15%, Shanghai + 28%, Nikkei +13%), given the clear signals we are hearing from global policymakers, there is no reason to think this should end. One of Keynes’ most important lessons was that ‘markets can remain irrational longer than you can remain solvent’. The point being that even if there is concern that markets have rallied to significantly overvalued levels, there is nothing to stop them from going further in the short run. Another interesting weekend article, this by Kevin Muir, highlighted the dichotomy between current retail enthusiasm for equity markets being so different from professional skepticism in the current situation. His point was one side of the argument is going to be really wrong. My take is that it is more a question of timing with an easily envisioned scenario of a further short-term rally to even more absurd valuation levels before an eventual reversal on some heretofore unseen concern (hard Brexit? US-China trade talks break down? Hot war after Iran tries to shut down the Strait of Hormuz?) The point is, there are still plenty of potential concerns that can derail things, but for now, it is all about easy money!

For bond markets, things are also looking great. After all, if there is no further policy tightening on the horizon, and inflation remains quiescent, government bonds should continue to rally. This is especially so if we see Eurozone economic weakness start to spread more widely. As to corporate bonds, low policy rates and ongoing solid economic activity point to spreads maintaining their current extremely tight levels. The hunt for yield will continue to dominate fixed income investing and that means tighter spreads across all asset classes.

Finally, for the currency markets this is a much more nuanced picture. This is because currencies remain a relative game, not an absolute one like stocks and bonds. So who’s policy is the tightest? Arguably, right now the US. Is that going to change in the near-term? While the Fed has clearly stopped raising rates, and will be ending QT shortly, the ECB is discussing further stimulus, the BOJ is actively adding stimulus, the PBOC is actively adding stimulus and the BOE remains mired in the Brexit uncertainty with no ability to tighten policy ahead of a conclusion there. In other words, the US is still the belle of the ball when it comes to currencies, and there is no reason to expect the dollar to start to decline anytime soon. In truth, given the idea that current policies are ostensibly priced into the market already, and that there are no changes seen in the medium term, I imagine that we are setting up for a pretty long period of limited movement in the G10 space, although specific EMG currencies could still surprise.

On the data front, it is particularly quiet this week, and with the Fed on the calendar for next week, there will be no more speakers until the meeting.

Today New Home Sales 650K
Thursday Initial Claims 200K
  Durable Goods 0.8%
  -ex Transport 0.2%
Friday Q1 GDP (revised) 2.1%
  Michigan Sentiment 97.0

We will see the final data point in this month’s housing story, which has been pretty lousy so far as both Housing Starts and Existing Home Sales disappointed last week. (Anecdotally, I see the slowdown in my neighborhood, where historically there have been fewer than 2 homes for sale at any given time, and there are currently 7, with some having been on the market for at least 9 months.) We also see the second look at Q1 GDP, with a modest downtick expected to 2.1%, still running at most economists’ view of potential, and clearly much faster than seen in either Europe or Japan. As I said, there is nothing that points to a weaker dollar, although significant dollar strength doesn’t seem likely either. I think we are in for some (more) quiet times in FX.

Good luck