Blain's Morning Porridge - What happens as the Quantitative Easing Era draws to a close.. crap p
Blain’s Morning Porridge – April 5th 2017
“You can use all the quantitative data you can get, but you still have to trust what you feel in your gut...”
I suppose I really ought to be writing about the immediate markets, and what’s occurring across the street and bond markets. Maybe I should have a quick rant about the latest Deutsche Bank travails as disenchanted staff leave in droves because they didn’t get big bonuses? Or maybe Fed presidents giving out insider information? Or how about the French election debate (didn’t understand a word, but I think Le Pen lost..) Or the China/US summit or Friday’s payroll data..?
I suppose I should, but this morning I’m thinking more about longer-term issues…
We can worry about political uncertainty and electoral surprises, but maybe it’s time to anticipate something real and increasingly tangible: What is going to happen to markets as the QE era comes to an end?
What happens when central banks stop distorting markets through their asset buying programmes, and Negative and Zero Interest Rates become a historical footnote? Everyone thinks about normalisation, but are markets expecting it?
Yesterday a client asked about the likely effects on markets when it happens. He was following up on my comments about unwinding the Fed’s balance sheet and re-investment of coupon income. If the Fed to simply dump its billions of Treasury and Mortgage bonds on markets, then I suspect we’ll have to add another digit to our yield calculators..
I don’t think anything so sudden or devastating will happen, but we are entering into a new phase of the never-ending financial game where fiscal policy issues may once more be discussed in polite company, and QE will become something we’d probably like to forget.
What are the long-term consequences of QE in the US? What will the end of the Bank of England’s distortion games do to the sterling corporate markets? Even the ECB is muttering about ending extraordinary policy at some point, although the potential dangers of tapering its bond buying and upsetting the fragile balance of expectations within Europe are not for the faint-hearted! Japan? What else can they do?
Some macro-believers might believe Zero and Negative interest rate policies have driven the apparent recovery of Europe and Japan… but they really should examine the reality. When the cost of money is zero, then it’s worth nothing. If reducing European unemployment to just under 10% (and still 18% unemployment in Spain), and growth rates still measured with a decimal point in front of them (which is, admittedly, better than a minus sign), none of it sounds like a screaming success.
Meanwhile, I’ve seen a number of articles in the FT and elsewhere wondering about just how effective QE policies have been.
What they should really be asking is how will their unwind impact markets..
The last 8 years of monetary experimentation has created the most massive market distortion, and held back real economic progress. Global growth is sort of back on track, but financial markets are non-aligned, and a correction looks likely. I suspect the economic history books will look back on the early decades of the 21st Century and conclude it was all a horrible mistake.
In the short-term, some QE driven policies were a massive success – shoring up collapsing sentiment following the Global Financial Crisis. Most notable was the ECB pumping money into banks via LTROs which were then invested into government bond markets. The effect was to stem off a systemic government credit crisis, and to support the banks. It became a massive winner when the ECB started outright buying. Tick box. Everyone loves the ECB… right up until they aren’t buying.
But… the long-term global effects of pumping massive amounts of money into the system through bond purchases has simply inflated markets to unrealistic valuations. Inflation in bond markets caused by the massive central bank buying binge migrated across financial assets as money went from fixed income into stocks in search of returns. The search for yield and financial osmosis has driven prices higher across other easy to trade “value” assets – from classic cars, fine wines and the art market. The alternative asset market – where I now spend the bulk of my time – has been a major beneficiary.
But, no one has been particularly interested in real assets. Commodities are commodities and are easily valued through real demand and supply, which is a function of the real economy. Financial assets are a function of where markets perceive value. They are very different concepts.
I would challenge anyone to show me how effective QE has been in terms of generating growth. The concept that central banks buying bonds would force investors to invest in real business worked in a surprising way. As the central banks set themselves up to tighten bond markets, Funds piled into to buy corporate bonds. Any business found its access to piles of money in the bond markets wide open. So they borrowed and borrowed some more. But, these funds were then spent, not on new plant and machinery, but on share buy-backs – further inflating stock prices and rewarding senior executives. Side effects included greater financial inequality, and weaker corporate balance sheets as they binged on debt.
So what happens when the QE spigot is turned off?
Do bond spreads widen? Do stock markets dust themselves off and realise there won’t be the financial gravitational boost that QE provided? Do the imbalances between the real economy and the imaginary world of financial values resolve themselves?
How that plays out is going to be very interesting indeed…
I suspect what we are going to need to end the era of extraordinary monetary policy will be a final act of the most extraordinary kind. To avoid the dislocation that will follow unwinding bond positions held by the central banks, lets just …. “make them go away.” I’ve suggested it before. Give the central banks a zero-coupon perpetual note representing their holdings of government obligations (basically a glorified bank note) and then we pretend it never happened and we’ll never ever speak of it again…
My conclusion is QE was a pretty dismal party, but we’ve still got to clean up the almighty mess its left behind.
Out of time..
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Bill Blain