If markets are trying to send us a message, I for one am not quite sure what it is.
Following the sharpish correction in tech stocks on Friday, there was general weakness in equity prices around the globe but whether it is fair to suggest that this is the result of anything close to “contagion” might be carrying the blame game a little too far.
If the Dow losing 0.17%, the S&P shedding 0.098%, the FTSE 0.205% or the Nikkei 0.052% represents contagion, then contagion it be. But close your eyes or look away from the sharp correction in an asset class that had been widely touted as being massively overpriced and there is nothing too scary left.
Please don’t get me wrong. I don’t think risk assets are cheap. I don’t even think that they are fairly priced. I think of them as being rudely rich but just because the price is wrong does not mean that they are about to go to the dogs. It was the authorities who in 2008 decided to began pumping endless cash into the financial system to delay the over-indebteded and overleveraged chickens from coming home to roost and now they have found out that they are sitting at the wrong end of the branch that they were busily sawing off.
If they were to do now what they surely know they ought to have done when they had the opportunity nine years ago, namely let the financial system deleverage itself and the economy find growth equilibrium, then there would now not be the fear of what might happen on the follow if, as and when policy is normalised.
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Can the Fed be happy when it knows that, despite winding up to its second tightening move of the year, both stocks and bonds are still rallying? There is barely a doubt that Madame Yellen and her merry men will on the one hand feel mightily relieved that there has, as yet, been no repeat of the “taper tantrum” but on the other they must also be wondering why it is that markets absolutely don’t seem to care what they are signalling.
Rates go down because the economy is weak and stocks go up on the back of that age-old discounted cash flow model. Rates go up again and stocks still go up because the Fed is seemingly comfortable with the development of said same economy. If that thinking - or is it acting without thinking? - isn’t flawed, what the hell is?
The great Fed chairman William McChesney Martin, the long-serving boss man from 1951 to 1970, coined the phrase that it is Federal Reserve’s responsibility to take away the punch bowl just as the party gets going. Although often quoted, there has been no sign since the accession of Alan Greenspan to the same office of punchbowls being whipped off the table in good time. On the contrary. Who can forget the so-called “Greenspan put”, a perception by markets that the chairman would always lead the FOMC to attune policy to the needs of the markets first and to the rest of the economy second? That is not to say that that monetary policy really was ever driven by market levels but who cares as long as perception is reality and everybody’s getting fat.
There is now a subliminal belief that whatever the Fed does, it will do so with at least one and a half eyes on the markets. That, if one looks at the other side of the coin, explains why markets are so utterly sanguine with respect to tomorrow’s impending tightening.
BEFORE CONTINUING
I was tickled when coming across an article this morning that also looked at the other aspect of monetary normalisation which is, drum roll please, the much-vaunted shrinking of the Fed’s balance sheet. Regular readers will recall my immediate response to the first broaching of the subject that came to light in the minutes of the March 15 FOMC meeting. Who, I wondered, was going to pick up the slack that would be caused by the Fed unwinding its QE holdings, whether by osmosis or by outright selling? And what effect would it have on the yield curve in general and on long-term rates in particular if they, after years of central bank manipulation, were again to find themselves exposed to raw market forces where money talks and bullshit walks?
More to the point, there is an entire generation of traders and investment managers out there who have never, ever worked in an environment that didn’t have an implied central bank provided safety net and that was driven entirely by the money, speak capital, demanded by issuers and concomitantly supplied by investors.
With reference to the balance sheet shrinkage programme, Fed Governor Jerome Powell told the Economics Club of New York: “We have made no decision about the long-run framework and we are not going to make one before the beginning of the normalisation process.” In other words he is telling us that the Fed won’t decide how it plans to shrink the balance sheet until it begins to shrink the balance sheet. If I read that correctly, we are being told in a very roundabout way that the Fed hasn’t got a clue how it is going to unload the US$3.7trn of securities it has bought since the QE programme began without sinking the bond markets. In total it now owns US$2.5trn of Treasuries and US$1.7trn of mortgage-backed securities.
Compared to the onset of tapering, selling down the balance sheet is dynamite but markets have decided this to be a non-event. Either that or they concur with my initial reaction, which was that this will never happen and if it does it won’t be completed within our lifetimes and possibly not those of our children either. The central banks, the Fed, BoE, BoJ and ECB included, have all painted themselves into a very tight corner and it seems as though markets are comfortable, despite the rhetoric, that it is there that they are going to stay. Either that or markets are utterly oblivious to the biggest risk to stability since Noah was advised to build the ark.
PLEASE TAKE YOUR CHANGE
Finally, Downing Street has let it be known that the Queen’s Speech may be postponed from June 19. Unless I am mistaken, Her Majesty will have better things to do as Royal Ascot begins on Tuesday and goes on for the rest of the week. Unless Mrs May wants to right royally piss the Queen off and hear that famous cry of “Off with her head” she’d be advised to think again. Another classic May U-turn in the making?