Why the Fed is no longer the main game in town

Yesterday the BIS praised financial markets for spotting the paradigm shift that they would no longer be spoon fed by central banks. That the real risk, in fact, came from judging the massive policy uncertainty that Albert Edwards so beautifully demonstrated in his chart which makes him panic. But neither have yet pointed out that the framework for judging monetary policy doesn’t work when applied to fiscal policy. Monetary policy is on a continuum: it’s either easing or tightening. Sure, that picture has become rather blurred as the years into unconventional policy have progressed, but the dial moves between the two as decisions are thrashed out by monetary policy committees who sit on that spectrum. If anything, the most recent ECB meeting shows how much of a busted flush monetary policy has become. It was the ultimate compromise between the hawks and the doves, and really didn’t do anything other than buy Draghi some more time while placating everyone else around the table.

This in itself should be a signal for how politics works. It’s a process of compromises, thrashed out by negotiation. That in itself can take the form of backroom deals, public brinkmanship, and a spewing forth of headlines as people brief and counter-brief to get the pressure and momentum to get their way. It’s why you might have to go to the edge to ensure you pull yourself back to the centre. Tsipras’ bailout work in Greece was a prime example of this. By threatening to walk away, he made it more likely that a deal would be done.

This is non-linear, and markets will freak out when they realise the truth. Despite the BIS’ hopes, they’re not there yet. Check out volatility levels:

Still sitting around 2015 levels… but interestingly becoming more divergent between asset classes – and most significant of all, the bond vols are the highest. This happened during the 2013 taper tantrum, and if anything the surprise right now is that we’re not more surprised. US 10year yields have jumped from 1.75% to 2.50% in a month, after all. That has a real life impact. But markets learn, don’t they, and the lesson of this year was ignore the noise, buy the dip. It’s been the message for years, because we have had so many flash crashes. Bobby’s Dream – but now we’re waking up to the nightmare.

Exhibit A: He’s not even President yet, but Donald Trump has already wiped billions off defence stocks and Boeing shares with just 140 character tweets. Here’s the Bloomberg headlines:

“Trump smashes defence shares” in reaction to tweet: “The F 35 program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after January 20th.”

These moves are just a warning signal. He’s not even got his whole team in place yet; he’s not even taken up his seat yet; and he wiped BILLIONS off defence stocks. And this is the man who is leading a Reaganite Republican Reflation? Even if he does, it will be in the most volatile way possible.

This is Government by Tweet. Don’t even think that you or any of us know how that will pan out. Not least by a market that is yet to understand how political risk even works.

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