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G-20 Needs To “Man Up” Or Risk Sparking Market Chaos, Citi Warns
G-20 Needs To “Man Up” Or Risk Sparking Market Chaos, Citi Warns
Over the past month or so, anticipation has built among market participants for some manner of coordinated policy response at this weekend’s G20 summit in Shanghai. The hoped for agreement would ideally be something akin to the 1985 Plaza Accord between the United States, France, West Germany, Japan, and the United Kingdom, which agreed to weaken the USD to shore up America’s trade deficit and boost economic growth.
Calls for coordinated action come on the heels of a turbulent January in which collapsing crude, RMB jitters, and worries that central banks are out of bullets have sowed fear in the minds of investors. “We remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations and credit conditions,” BofA said last week, ahead of the summit.
“Don’t expect a crisis response in a non-crisis environment,” Lew said in an interview broadcast Wednesday with David Westin of Bloomberg Television. “This is a moment where you’ve got real economies doing better than markets think in some cases.”
Whether or not you agree with Lew’s assessment of “real economies” or not, the message was clear. The US isn’t set to support some kind of joint statement on fiscal stimulus and may not even be willing to be part of a consensus on the need to implement emergency measures to juice global growth and trade.
On Friday, the soundbites are rolling in as the world’s financial heavyweights opine on the state of the decelerating global economy and the turmoil that likely lies ahead for markets.
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A Contagious Crisis Of Confidence In Corporate Credit
A Contagious Crisis Of Confidence In Corporate Credit
Credit is not innately good or bad. Simplistically, productive Credit is constructive, while non-productive Credit is inevitably problematic. This crucial distinction tends to be masked throughout the boom period. Worse yet, a prolonged boom in “productive” Credit – surely fueled by some type of underlying monetary disorder – can prove particularly hazardous (to finance and the real economy).
Fundamentally, Credit is unstable. It is self-reinforcing and prone to excess. Credit Bubbles foment destabilizing price distortions, economic maladjustment, wealth redistribution and financial and economic vulnerability. Only through “activist” government intervention and manipulation will protracted Bubbles reach the point of precarious systemic fragility. Government/central bank monetary issuance coupled with market manipulations and liquidity backstops negates the self-adjusting processes that would typically work to restrain Credit and other financial excess (and shorten the Credit cycle).
A multi-decade experiment in unfettered “money” and Credit has encompassed the world. Unique in history, the global financial “system” has operated with essentially no limitations to either the quantity or quality of Credit instruments issued. Over decades this has nurtured unprecedented Credit excess and attendant economic imbalances on a global scale. This historic experiment climaxed with a seven-year period of massive ($12 TN) global central bank “money” creation and market liquidity injections. It is central to my thesis that this experiment has failed and the unwind has commenced.
The U.S. repudiation of the gold standard in 1971 was a critical development. The seventies oil shocks, “stagflation” and the Latin American debt debacle were instrumental. Yet I view the Greenspan Fed’s reaction to the 1987 stock market crash as the defining genesis of today’s fateful global Credit Bubble.
The Fed’s explicit assurances of marketplace liquidity came at a critical juncture for the evolution to market-based finance.
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Negative Interest Rates Already In Fed’s Official Scenario
Negative Interest Rates Already In Fed’s Official Scenario
Over the past year, and certainly in the aftermath of the BOJ’s both perplexing and stunning announcement (as it revealed the central banks’ level of sheer desperation), we have warned (most recently “Negative Rates In The U.S. Are Next: Here’s Why In One Chart”) that next in line for negative rates is the Fed itself, whether Janet Yellen wants it or not. Today, courtesy of Wolf Richter, we find that this is precisely what is already in the small print of the Fed’s future stress test scenarios, and specifically the “severely adverse scenario” where we read that:
The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities.
As a result of the severe decline in real activity and subdued inflation, short-term Treasury rates fall to negative ½ percent by mid-2016 and remain at that level through the end of the scenario.
And so the strawman has been laid. The only missing is the admission of the several global recession, although with global GDP plunging over 5% in USD terms, we wonder just what else those who make the official determination are waiting for.
Finally, we disagree with the Fed that QE4 is not on the table: it most certainly will be once stock markets plunge by 50% as the “severely adverse scenario” envisions, and once NIRP fails to boost economic activity, as it has failed previously everywhere else it has been tried, the Fed will promtply proceed with what has worked before, if only to make the true situation that much worse.
Until then, we sit back and wait.
Here is Wolf Richter with Negative Interest Rates Already in Fed’s Official Scenario
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“Pandora’s Box Is Open”: Why Japan May Have Started A ‘Silent Bank Run’
“Pandora’s Box Is Open”: Why Japan May Have Started A ‘Silent Bank Run’
As Goldman’s Naohiko Baba previously explained, NIRP in Japan will not actually boost the economy: “we do have concerns about the policy transmission channel. Policy Board Member Koji Ishida, who voted against the new measures, said that “a further decline in JGB yields would not have significantly positive effects on economy activity.” We concur with this sentiment, particularly for capex. The key determinants of capex in Japan are the expected growth rate and uncertainty about the future as seen by corporate management according to our analysis, while the impact of real long-term rates has weakened markedly in recent years.”
What the BOJ’s NIRP will do, is result in a one-time spike in risk assets, something global stock and bond markets have already experienced, and a brief decline in the Yen, one which traders can’t wait to fade as Citi FX’s Brent Donnelly explained yesterday.
NIRP will also have at most two other “positive” consequences, which according to Deutsche Bank include 1) reinforcing financial institutions’ decisions to grant new loans and invest in securities (if only in theory bnecause as explained further below in practice this may very well backfire); and 2) widening interest rate differentials to weaken JPY exchange rates, which in turn support companies’ JPY-based sales and profit, for whom a half of consolidated sales are from overseas.
That covers the positive. The NIRP negatives are far more troubling. The first one we already noted yesterday, when Goldman speculated that launching NIRP could mean that further QE is all tapped out:
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Fed Vice Chair Explains Why The Fed Is Still Obsessing With Negative Interest Rates
Fed Vice Chair Explains Why The Fed Is Still Obsessing With Negative Interest Rates
Two months ago, and roughly 6 weeks before the Fed’s first rate hike in 9 years, Janet Yellen warned that if the “outlook worsened, the fed might weight negative rates” adding that “negative rates could help encourage banks to lend.”
Moments ago, in a speech titled “Monetary Policy, Financial Stability, and the Zero Lower Bound” delivered before the American Economic Association in San Francisco, the Fed’s second in command, Vice Chairman Stanley Fischer while discussing the equilibrium real interest rate, or r* (or the real interest rate at which the economy would settle at full employment and with inflation at 2 percent, provided the economy is not at the ZLB), unexpectedly hinted once again at the potential advent of negative rates in the US, two weeks after the Fed’s raised the interest rate to a 25-50 bps corridor except of course for December 31 when as we noted, the Fed Funds dropped to 0.12%, suggesting that banks are perfectly ok with hiking rates… except when it comes to quarter and year-end window dressing for regulatory, compliance and public filing purposes.
Specifically, Fischer discussed what steps, if any, can be taken to mitigate the constraints associated with the ZLB? His second answer: NIRP. To wit:
Another possible step would be to reduce short-term interest rates below zero if needed to provide additional accommodation. Our colleagues in Europe are busy rewriting economics textbooks on this topic as we speak-and also helping us to remember earlier discussions of negative interest rates by Keynes, Irving Fisher, Hicks, and Gesell.
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Here Is The Complete Scenario In Which The Fed Hikes Rates, Starts A Recession, And Launches QE4
Here Is The Complete Scenario In Which The Fed Hikes Rates, Starts A Recession, And Launches QE
Seven years after the Fed unleashed ZIRP and QE to “fix the economy”, it has finally admitted that ZIRP and QE failed to do that (although they certainly succeeded in blowing the biggest asset bubble ever), and for the past 6 months the Fed has engaged in what may be the most ridiculous case of revisionist history, as the narrative has been flipped on its head, and now the all too wise career economists of the Fed (with the help of a few good ex-Goldman bankers) are pitching the first rate hike in nearly a decade as the solution to all the economy’s problems.
For now the equity market has played along with this grotesque flip-flop in monetary policy, first by rising two months ago on terrible job numbers which made the December rate hike less realistic, and then rising some more in the aftermath of the October “hawkish” Fed announcement and minutes, which in no uncertain terms warned a December rate hike is coming after all, poor economic data be damned.
To be sure, while stocks as usual remain stuck in their imaginary ivory tower where good news is great, and bad news is even greater, other assets have been far less enthusiastic. In fact, as we have shown repeatedly, the dramatic flattening of the yield curve (via the 2s30s) is now screaming policy error.
Yet if bonds foresee a major monetary policy “error” why do stocks remain oblivious? One attempt at an answer was provided by Goldman late last week when the firm suggested that the natural rate of the economy (to which the Fed will hike rates before re-easing) has declined and will remain lower for longer: in other words, the Fed’s experiment has weakened the economy so much, its potential growth rate has been cut in half in the past decade.
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The Yield Curve and GDP – a causal relationship?
The Yield Curve and GDP – a causal relationship?
One of the most reliable indicators of an imminent recession through recent history has been the yield curve. Whenever longer dated rates falls below shorter dated ones, a recession is not far off. Some would even say that yield curve inversion, or backwardation, help cause the economic contraction.
To understand how this can be we first need to understand what GDP really is. Contrary to popular belief, GDP only has an indirect relation to material prosperity. Broken down to its core component, GDP is simply a measure of money spent on goods and services during a specified period, usually a year or a quarter.
However, since money itself is a very fleeting concept we need to dig deeper to fully understand the relation between the slope of the yield curve and GDP. The core of money is its function as the generally accepted medium of exchange, but today that is much more than the cash in your wallet. For example, the base money, provided by the central bank, consist of currency in circulation and banks reserves held at the central bank.
From these central bank reserves the commercial banking system can leverage up, through fractional reserve lending practice, several times over. It is important to note that broader money supply measures, such as M2, is merely a reflection of banks leverage on top of base money. As a bank makes a loan to a borrower the bank creates fund which can be used as means of payments to whatever the borrower wants to spend the newly acquired money on. Obviously, these money claims will in turn create new deposits, which can be used to create new loanable funds and so on ad infinitum.
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