The Largesse They Bestow

The status is clearly still quo
For central bank policy so
All rates are on hold
And markets consoled
By all the largesse they bestow

But Covid continues to spread
And Q1 growth seems to be dead
So, Christine and Jay
Will soon have to say
More QE is coming ahead

It has been an active week for central banks so far, at least with respect to the number of meetings being held.  By the end of today we will have heard from six different major central banks from around the world (Canada, Brazil, Japan, Indonesia, Norway and the ECB) although not one of them has changed policy one iota.  The implication is that monetary policy has found an equilibrium for now, with settings properly attuned to the current economic realities.

A summary of current central bank policies basically shows that whatever the absolute level of interest rates being targeted, it is almost universally at historically low levels, with 14 key banks having rates 0.25% or lower.  The point is, a central bank’s main tool is interest rate policy, and while negative nominal rates are clearly viable, after all the SNB, ECB and BOJ currently maintain them, central banks are clearly running out of ammunition.  (PS; the efficacy of negative rates has been widely argued and remains unproven.)  Interestingly, prior to this crisis, reserve requirements were seen as an important central banking tool, with a broad ability to inject more liquidity into the markets or remove it if so desired.  However, in the wake of the GFC, when banks worldwide were shown to be too-highly levered, it seems central banks are a bit more reluctant to open those floodgates.  Even if they did, though, it is unclear if it would make a difference.  Perhaps the lesson we should all learn from the Covid crisis, especially the central banks themselves, is that monetary policy is very good at slowing down economies all by itself, but when it comes to helping them pick up, they need help.

So, with interest rate policy basically at its limit, central banks have been forced to implement new and different tools in their quest to support their respective economies, with QE at the forefront.  Of course, at this point, QE has also become old hat, and has yet to be shown to support the economy.  It has, however, done a bang-up job supporting equity markets around the world, as well as other risk assets like commodities.  And that is exactly what it was designed to do.  QE’s transmission mechanism was to be a trickle-down philosophy, where the ongoing search for yield by investors pushed capital into riskier ventures, helping to support increased investment and more economic growth.  Alas, the only thing QE has really served to do is inflate a number of asset bubbles.  This was never clearer than when the data showed more money was spent by corporations on stock repurchases than on R&D.  Thus, if the stated goal of QE was to support economic growth, it is fair to say it has failed at that task.

At any rate, a recap of the central bank comments shows that economic forecasts and expectations have been tweaked lower for Q1 and higher for Q2 and Q3 with a universal assumption that the widespread inoculation of the population via the new vaccines will help reopen economies all over.  And yet, if anything, we continue to hear of more and more draconian measures being put into place to slow the spread of Covid.  This certainly confirms the idea of a weak Q1 growth pattern, but the leap to a stronger Q2 is harder to make in my mind.

Add it all up and it appears that central banks, globally, are pretty much all in the same position, promulgating extremely easy monetary policy with limited hope that it will, by itself, reignite economic growth.  In effect, until it is shown that the vaccines are really changing people’s behavior, assuming governments allow people back out of the house, central banks can do all they want, and it will not have much impact on the economy.  Markets, however, are a different story, as all that monetary largesse will continue to flow to the riskiest, highest yielding assets around.  Until they don’t!  It will not be pretty when this bubble deflates.

So, is that happening today?  Not even close.  Equity markets continue to rise almost universally, with the Nikkei (+0.8%) and Shanghai (+0.8%) leading the way in Asia.  Europe, meanwhile, is not quite as robust, but still largely in the green led by the DAX (+0.5%) and FTSE 100 (+0.25%) although the CAC (-0.1%) is lagging a bit.  And not surprisingly, US markets continue to power ahead on the ongoing belief that there will be yet more stimulus coming, so futures are all higher by roughly 0.3% or so.

Bond markets are playing their part as well, with 10-year yields higher in all the major markets, with Treasuries, Bunds, OATs and Gilts all seeing yields climb about 1 basis point.  The interesting thing about Treasuries, and truthfully all these markets, is that since the Georgia run-off election, when the market assumption for more stimulus was cemented, the yield has barely moved.  Let me say that the reflation trade seems to be on hold, at least for now.

For a change, oil prices have edged a bit lower this morning, with WTI down 0.6%, as it consolidates its spectacular gains since November.  Gold is little changed, although it had a big day yesterday, rising 1.5% as inflation concerns seem to be percolating.  And finally, as perhaps a harbinger of that deflating bubble, Bitcoin is lower this morning and has been falling pretty steadily, if with still spectacular volatility, for the past 2 weeks, and is now down 24% from its recent highs.

Finally, the dollar is under clear pressure this morning, falling against all its G10 peers and all but one of its EMG peers.  In G10, NOK (+0.8%) leads the way as the Norgesbank did not cut rates which some had expected and were less negative on the economy than expected as well.  But NZD (+0.7%) and SEK (+0.6%) are also putting in fine performances amid stronger commodities and hopes for more stimulus.  In fact, CAD (+0.15%) is the laggard, although it had a strong performance yesterday (+0.7%) after the BOC left rates on hold rather than performing a microcut (10 bps) as some analysts had expected.

In the EMG space, CLP (+1.15%) and BRL (+1.1%) lead the way with the former benefitting from strong investor demand in USD and EUR denominated government bonds, leading to a positive outlook, while the latter seems to be responding to hints that tighter policy may be coming soon given rising inflation forecasts.   But really, the dollar’s weakness is pervasive across all three major blocs.

We finally see some data today as follows: Initial Claims (exp 935K), Continuing Claims (5.3M), Housing Starts (1560K), Building Permits (1608K) and Philly Fed (11.8).  The Claims data has certainly deteriorated during the past several weeks given the renewed lockdowns around the country, which doesn’t bode well for the NFP report in 2 weeks’ time.  The housing market remains on fire given the ongoing exodus to the suburbs from large cities and the historically low mortgage rates.  Meanwhile, Philly Fed should show the strength of the manufacturing sector, which continues to far outperform services.

Still no Fed speakers, so beyond the data, which is all at 8:30, we will also hear from Madame Lagarde in her press conference at the same time.  The risk, to me, is that she comes off more dovish than the market anticipates, thus halting the euro’s modest rebound.  But otherwise, there is no obvious catalyst to stop the risk-on meme and dollar’s renewed decline.

Good luck and stay safe