Liquidity Supernova and the Big Ugly Flaw
From the report authored by BofA Merrill’s chief investment strategist Michael Hartnett: “The $1 trillion flow that conquers all… One flow that matters… $1 trillion of financial assets that central banks (European Central Banks & Bank of Japan) have bought year-to-date (= $3.6tn annualized = largest CB buying in past 10 years); ongoing Liquidity Supernova best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro."
A strong case can be made that Q1 2017 experienced the most egregious monetary stimulus yet. No financial or economic crisis – and none for years now. Consumer inflation trends have turned upward on a global basis. Stock prices worldwide have surged higher, with U.S. and other indices running to record highs. At the same time, global bond yields remained just off historic lows. Home prices in many key global markets have spiked upward. Meanwhile, central bank balance sheets expanded at a $3.6 TN annualized pace (from BofA) over the past four months.
With U.S. bond yields reversing lower of late, there’s been a fixation on weaker-than-expected Q1 U.S. GDP. Meanwhile, recent data have been stronger-than-expected in China, Europe and Japan. EM has been buoyed by strong financial inflows and a resulting loosening of financial conditions. Thus far, Fed baby-step normalization efforts have been overpowered by the “liquidity supernova”.
April 21 – Reuters (Balazs Koranyi): “Global growth and trade appear to be picking up strength but risks for the euro zone economy remain tilted to the downside, so 'very substantial' accommodation is still necessary, European Central Bank President Mario Draghi said on Friday. In a statement largely reflecting the bank's March policy statement, Draghi said that while the risk of deflation has largely disappeared, underlying inflation has shown no convincing upward trend.”
April 20 – Reuters (Leika Kihara): “Japan has benefitted from global tailwinds that boosted exports and factory output, [Bank of Japan Governor Haruhiko] Kuroda said, describing its economy as ‘expanding steadily as a trend’ - a more upbeat view than last month. But he offered a bleaker view on Japan's inflation, saying it lacked momentum with no clear sign yet it was shifting up. ‘That's why the BOJ will continue its ultra-easy monetary policy to achieve its 2% inflation target at the earliest date possible,’ he said.”
Bank of Japan Governor Haruhiko Kuroda, responding to a question from Bloomberg's Francine Lacqua: “The inflation rate continues to be quite sluggish. Although the real economy is improving – doing better than we anticipated just a few months ago. Like the IMF – the IMF itself also made up the [global growth] rate this time compared to the January figure. So, as far as the Japanese economy is concerned, yes the economy is doing better than we anticipated…, but the inflation front has not much improved, unfortunately.”
Mr. Kuroda is quick with a smile and carries an infectious laugh; seems like a nice guy. Seeing his big grin after stating “the inflation front has not much improved, unfortunately,” I couldn’t help but think he’s not at all unhappy with inflation stuck below target. And why not? The BOJ can proceed with its historic experiment in government debt monetization, in the process administering more liquidity upon a global system already inundated with central bank “money”. The Fateful Day of Reckoning and attendant very difficult decisions – for Japan and the rest of the world – can be relegated to some future date. Historians will surely appreciate what few are willing to admit today: it’s crazy that Haruhiko Kuroda has come to wield such incredible power over global finance and securities markets.
Japan and Europe confront deep structural issues. In particular, Japan faces an aging population and a conservative, high-savings society. It remains a powerful manufacturer and runs persistent Current Account surpluses. In the face of unprecedented debt monetization, the yen has proven impressively resilient. What’s more, the yen’s 7% y-t-d gain (versus $) will not be supportive of the BOJ attaining its inflation target. As for the ECB’s Draghi, it’s even more difficult to argue that low inflation remains a scourge worthy of “whatever it takes.” Yet he’s obviously in no rush to rethink his aggressive printing operations – no hurry whatsoever to face his Day of Reckoning.
Here at home, inflationary biases throughout assets markets have over recent months turned increasingly robust. Stock prices surged to record highs, while home price inflation picked up steam as sales transactions escalated to the strongest pace since 2007. Debt issuance has been running at a record rate. In spite of it all, Fed chair Yellen has been quick to note that inflation remains “slightly” below the Fed’s 2% target. Rather quickly the markets question whether the Yellen Fed has the fortitude for a couple additional baby-step rate increases this year.
Can we all agree that this central bank fixation on a 2% consumer price inflation target is borderline ridiculous? Consumer price dynamics have changed momentously over the past 20 years. Most importantly, the technology revolution has basically created an unlimited supply of goods and services. From smart phones and tablets to digital downloads, companies can now easily expand output to meet heightened demand. There has been as well the equally momentous move to “globalization” – with seemingly limitless cheap labor coupled with unlimited cheap finance fundamentally boosting the supply of inexpensive goods and services globally.
Technological advancement has played a profound role in oil extraction, new energy technologies and energy conservation. There are as well advancements in pharmaceuticals and healthcare more generally. Even in basics like food, there is the proliferation of higher-priced organic and healthy-choice products. And somehow government economists are adept at constructing models and calculating hedonic adjustments to come to an accurate measure of true underlying CPI? And this single contrived data point has become key to policies that amount to a historic experiment in global activist monetary management? Wow.
I’m reminded of the mortgage finance Bubble period with chairman Greenspan supposedly fretting that booming housing markets were impervious to Fed “tightening” measures. I recall writing in the CBB at the time, “Greenspan could easily resolve this issue with two phone calls, and they’d both be local.” Fannie and Freddie were clearly at the heart of a historic Bubble in mortgage finance. Yet no one was willing to call the Fed out on the reckless GSEs and the powerful distortions emanating from the market embracing the implied Washington backing of agency obligations.
These days, virtually no one is willing to call out global central bankers on their notion that there is basically no limit to measures to be employed to achieve 2% CPI bogeys. Zero rates, negative rates, Trillions of monetization, acquire equities and corporate debt, market yield manipulation, etc. Risk be damned. Everyone is content to disregard that central banks have inflated epic Bubbles almost everywhere across virtually all asset classes – and they’re trapped.
The entire contemporary notion of “inflation” is deeply flawed. Years ago, I adopted the “Austrian” view: start with the expansion of Credit – “Credit/monetary inflation” – and then diligently monitor for price effects and inflationary consequences associated with the resulting increase in purchasing power.
Inflation can arise in myriad forms: rising consumer and producer prices; rising asset values and market distortions; increasing corporate profits and investment; trade and Current Account deficits; etc. And as the late Dr. Kurt Richebacher was so great at explaining, consumer prices were generally the least threatening inflationary manifestation. Central bankers could and would squeeze consumer inflation with tighter policy. Asset inflation, on the other hand, would be allowed (even nurtured) to develop into Bubbles that would inflate to the point of imparting deep structural (financial and economic) maladjustment. As we’ve witnessed for over twenty years now, there’s no constituency for thwarting rising asset prices.
After experiencing the mortgage finance Bubble fiasco, it’s difficult to comprehend that global central bankers have so aggressively embraced and promoted asset inflation. Central bankers have been hoping for modest self-reinforcing inflation in a general price level. General price inflation would, so the thinking goes, spur a commensurate increase in Credit that would support ongoing moderate increases in CPI.
Well, it may have worked that way in the past but no longer. Central bankers have ensured that the powerful inflationary biases reside throughout the asset markets. These days, monetary inflation works predominately to stoke asset inflation and Bubbles, with major ramifications for ongoing inequitable wealth distribution and system fragility more generally.
April 20 – Reuters (David Morgan): “U.S. President Donald Trump's tax reform plan will rely largely on future revenue gains from faster economic growth to justify major tax cuts, top Trump advisers said… As Trump's first 100 days in office draw to a close, the disclosure is the latest sign that the White House could part ways with congressional Republicans who want to pay for tax cuts by taxing imports and eliminating a business tax deduction for debt interest payments. ‘Some of the lowering in (tax) rates is going to be offset by less deductions and simpler taxes,’ Treasury Secretary Mnuchin said…’But the majority of it will be made up by what we believe is fundamentally growth and dynamic scoring,’…”
During the late-nineties Bubble period, there was ruminating over federal fiscal surpluses that were expected to extinguish much of outstanding Treasury debt. It was all a Bubble mirage.
Sunday’s first round French election will be captivating. A Marine Le Pen versus Jean-Luc Mélenchon second round would be a big issue for the markets. Markets Friday were somewhat concerned that Le Pen could receive a boost after this week’s terrorist shooting on Paris’ Champs- Élysées. For the most part, however, players were heartened by polls showing centrist Emmanuel Macron somewhat widening his narrow lead over Le Pen. Both François Fillon and Mélenchon remain within striking distance.
Crude was slammed almost 7%, as the GSCI commodities index sank 3.9% this week. And while OPEC remains an ongoing issue, China seemed to be at top of mind. It’s almost as if every headline related to tighter Chinese regulation – real estate finance, shadow-banking, wealth management products, insurance, corporate debt and repo leverage, Internet finance, the stock market – seems to help reawaken market fears of latent system fragilities. Timid policymaking has not only not worked, it’s has emboldened Bubble excess. Tough policies will be necessary but risk bursting the Bubble.
It’s evolved into a global issue: There’s no cure for major asset Bubbles other than unwinds. Once asset inflation becomes the prevailing inflationary manifestation it becomes impossible to inflate away the problem. Instead, central bank efforts to spur general inflation only exacerbate Bubbles and maladjustment. That’s The Big Ugly Flaw in this runaway global monetary experiment. Back when he served as president of the Dallas Fed, Richard Fisher espoused some cogent advice for global central bankers: The law of holes – when you find yourself in a hole, first you must stop digging. Well, the problem today is that instead of heeding Fisher’s “stop digging” they came together, called in the big backhoes and have been shoveling fanatically ever since.
Bloomberg's Francine Lacqua: “Do you worry - you’ve used a lot of tools – a lot of unconventional tools. Do you worry about your balance sheet – in terms of GDP it’s higher than that Fed’s.”
Bank of Japan Governor Haruhiko Kuroda: “Yes. We have acquired about 40% of JGBs outstanding. Which means about 80% of GDP equivalent of JGBs we have acquired. But this is a result of the quantitative and qualitative monetary easing, and we think that we can manage the enlarged balance sheet in a reasonable manner. Of course, once we exit from the QQE with yield curve control, we’ll have to consider how to deal with an enlarged balance sheet. But, like the Fed, I think we can manage the enlarged balance sheet in a reasonable way.”
Lacqua: “When is the ideal time to start talking about it [exiting QQE]?”
Kuroda: “It’s too early… Because our target rate is 2% - we’re still around zero percent inflation rate. So it’s a long way to go. So although we forecast that the inflation rate would gradually rise to our 2% and reaching the target sometime around fiscal 2018, it’s a long way to go. So, at this stage it’s premature to discuss in an exact way about an exit strategy.”
Lacqua: “Governor, what have you learned in your time as head of the BOJ? I don’t know if it is easier or more difficult than you thought to manage this complicated economy.”
Kuroda: “It’s maybe of course challenging, depending on the economic and market conditions when the BOJ starts to exit from the current QQE and yield control. But I think it can be managed in a reasonable way. So I have no particular concern about the increased balance sheet or negative interest rates on the short end. No.”