Peak Monetary Stimulus

Doug Nolan

October 28 – Bloomberg (Eliza Ronalds-Hannon and Claire Boston): “After all central bankers have done since the financial crisis to prop up bond prices, it didn’t take much for them to send the global debt market reeling. Bonds worldwide have lost 2.9% in October, according to the Bloomberg Barclays Global Aggregate Index, which tracks everything from sovereign obligations to mortgage-backed debt to corporate borrowings. The last time the bond world was dealt such a blow was May 2013, when then-Federal Reserve Chairman Ben S. Bernanke signaled the central bank might slow its unprecedented bond buying.”
German bund yields surged 16 bps this week to 0.16% (high since May), with Bloomberg calling bund performance the “worst month since 2013.” French yields jumped 18 bps this week (to 0.46%), and UK gilt yields rose 17 bps (to 1.26%). Italian yields surged a notable 21 bps to a multi-month high 1.58%.

A cruel October has seen German 10-year yields surge 31bps, with yields up 58 bps in the UK, 31 bps in France, 40 bps in Italy, 33 bps in Spain and 30 bps in the Netherlands. Ten-year yields have surged 43 bps in Australia, 40 bps in New Zealand and 25 bps in South Korea.

Countering global bond markets, Chinese 10-year yields traded Monday at a record low 2.60%. 
 
There seems to be a robust safe haven dynamic at work. It’s worth noting that China’s one-year swap rate ended the week at an 18-month high 2.73%, with China’s version of the “TED” spread (interest-rate swaps versus government yields) also widening to 18-month highs.

Here at home, 10-year Treasury yields this week jumped 12 bps to 1.85%, the high since May. 
 
Long-bond yields rose 15 bps to 2.62%, with yields up 30 bps in four weeks.

And while sovereign bond investors are seeing a chunk of their great year disappear into thin air, the jump in yields at this point hasn’t caused significant general angst. During the October sell-off, corporate debt has outperformed sovereign, and there are even U.S. high yield indices that have generated small positive returns for the month. Corporate spreads generally remain narrow – not indicating worries of recession or market illiquidity.

October 27 – Wall Street Journal (Ben Eisen): “By some measures, October is already a record month for mergers and acquisitions. Qualcomm $39 billion deal to buy NXP Semiconductors helped push U.S. announced deal volume this month to $248.9 billion, according to… Dealogic. That tops the previous record of $240.2 billion from last July… It was assisted by last week’s record weekly U.S. volume of $177.4 billion.”
And while bond sales have slowed somewhat in October, global corporate bond issuance has already surpassed $2.0 TN. The Financial Times is calling it “the best year in a decade,” with issuance running 9% ahead of a very strong 2015. According to Bloomberg, this was the third-strongest week of corporate debt issuance this year.

At this point, there’s not a strong consensus view as to the factors behind the backup in yields. Some see rising sovereign yields as an indication of central bank success: with inflation finally having turned the corner, there will be less pressure on central bankers to push aggressive stimulus. Others argue that central bankers are coming to accept that the rising risks of QE infinity and negative rates have overtaken diminishing stimulus benefits.

Importantly, there’s no imminent reduction in the approximately $2.0 TN annual QE that has been underpinning global securities and asset prices. It’s hard to believe it’s been almost three and one-half years since the Bernanke “taper tantrum.” With only one little baby-step rate increase to its Credit, rate normalization couldn’t possibly move at a more glacial pace.

There’s deep complacency in the U.S. regarding vulnerability to reduced monetary stimulus. 
 
The Fed wound down QE and implemented a rate increase without major market instability. I believe this was only possible because of the extraordinary monetary stimulus measures in play globally. “Whatever it takes” central banking, in particular from the ECB and BOJ, unleashed Trillions of liquidity (and currency devaluation) that certainly underpinned U.S. securities and asset markets. Prices of sovereign debt, including Treasuries, have traded at levels that assume global central banker support will last indefinitely. Markets have begun reassessing this assumption.

October 28 – Reuters (Leika Kihara): “As his term winds down, Bank of Japan Governor Haruhiko Kuroda has retreated from both the radical policies and rhetoric of his early tenure, suggesting there will be no further monetary easing except in response to a big external shock. In a clear departure from his initial ‘shock and awe’ tactics to jolt the nation from its deflationary mindset, he has even taken to flagging what little change lies ahead, trying predictability where surprise has failed. This new approach will be on show next week, when the BOJ is set to keep policy unchanged despite an expected downgrade in forecasts that could show Kuroda won't hit his perpetually postponed 2% inflation target before his five-year term ends in April 2018. ‘The days of trying to radically heighten inflation expectations with shock action are over,’ said a source familiar with the BOJ's thinking. ‘No more regime change.’”
My view that “QE has failed” has seemed extreme – even outrageous to conventional analysts. 
 
Yet Japan is the epicenter of the Bernanke doctrine of radical experimental inflationism. Unshakable central banker “shock and awe” and “whatever it takes” were supposed to alter inflationary expectations throughout the economy, boosting asset prices, investment, incomes, spending and – importantly – the general price level. Deflation, it was argued, was self-imposed.

It may have worked brilliantly in theory – it’s just not looking so bright in practice. An impervious Japanese CPI has continued to decline, while the central bank has pushed bond prices to ridiculous extremes by purchasing a third of outstanding government debt. Major risks associated with an out-of-control central bank balance sheet and asset Bubbles are not inconspicuous in Japan. There is today heightened pressure in Japanese policy circles to wind down this experiment before it’s too late. It will not go smoothly.

In the category “truth is stranger than fiction”, November 8th can’t arrive soon enough. 
 
Suddenly, it appears the markets may have some election risk to contemplate. And there will be no rest for the weary. The ECB meets one month later, on December 8th.

October 27 – Bloomberg (Jeff Black and Jill Ward): “European Central Bank officials signaled that they support extending asset buying beyond the earliest end-date of March, arguing that returning to a healthy level of inflation demands maintaining the pace as the economy heals. Speaking in London…, Irish central bank Governor Philip Lane said that the ‘broad narrative’ in the market about the ECB’s strategy on bond purchases is that it will continue until inflation is heading reliably toward the target of just under 2%. His comments echoed remarks by Executive Board member Benoit Coeure… and Spain’s Governor Luis Maria Linde… ‘March was always an intermediate staging post,’ said Lane. ‘The narrative of the euro area is that there’s been this moderate but sustained recovery, by and large driven by domestic factors, especially consumption. But inflation remains low compared to target and essentially that’s the assessment.’”
I’m not so sure Germany and the group of ECB hawks saw March as “always an intermediate staging post.” Draghi purposely avoided commencing the discussion of extending QE past March. What will likely be a heated debate will take place in December.

October 25 – Reuters (Gernot Heller): “There is a growing international consensus that monetary policy has reached the limits of its possibilities, German Finance Wolfgang Schaeuble told a group of government officials in Berlin… Schaeuble also said that he believed that there was an excess of liquidity and excess of indebtedness internationally.”Over recent months, German public opinion has turned even more against QE. ECB President Jens Weidmann has been opposed to QE from day one, and his skepticism has been shared by fellow German (ECB executive board member) Sabine Lautenschläger. A majority of Germans believe QE is hurting Deutsche Bank and the German banking system more generally. And there is growing frustration that the ECB is a mechanism for redistributing German wealth. The stakes for dismissing German concerns are growing.

Draghi has grown accustomed to playing dangerously. Front-running committee deliberations, he has signaled to the markets that QE will run past March. Comments and leaks from within the ECB have encouraged the markets to assume that aggressive stimulus will run uninterrupted for months to come. All this places great pressure on ECB hawks. And this is a group that has seen its concerns repeatedly rejected; a group that has surely become only more troubled by the course of Eurozone and global monetary policymaking. If they have much say in policy come December, markets will tantrum. I can imagine that Draghi’s pressure tactics must by this point be wearing really thin.

Fledgling “risk off” turned more apparent this week. Notably, the broader U.S. equities market came under pressure. Having outperformed over recent months, the now Crowded Trades in the mid- and small-caps saw prices drop 1.8% and 2.5%. In general, the beloved high dividend and low volatility stocks – colossal Crowded Trades – also badly lag the market. The REITS (VNQ) dropped another 3.6% this week, having declined 13% from August highs to trade at the lowest level since April. The homebuilders (XHB) declined to the low since March. It’s worth noting that Ford this week also traded to lows going back to March.

Abnormal has been around so long now we’ve grown accustomed. Fifteen-year mortgage rates at 2.78%. ARMs available at 2.75%. And I’m hearing automobile advertisements even more outrageous than 2007. “Lease Kia two for $222 a month.” How much future demand has been pulled forward by history’s lowest interest rates – and accompanying loose Credit.

QE is not disappearing any day soon. Yet there’s a decent argument that we’re at Peak Monetary Stimulus. The Fed is preparing for a hike in December. The Kuroda BOJ has lost its appetite for surprising markets with added stimulus. And I suspect the ECB is just over a month away from a contentious discussion of how to taper QE starting in March 2017. Market liquidity may not be a pressing concern today, but it will be in the not too distant future.

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