Fed’s dead, baby. Fed’s dead.

The final Fed meeting of the year, and it’s all fully priced for a hike. December hikes: Janet Yellen is a fan. Remember last year when the first one was supposed to cause utter disaster? Remember that last Dec, they thought they would be doing 4 hikes this year? Remember this September, deep in the bowels of “lower forever”, when US 10 year yields hit a record low of 1.32% and some thought the next move might be a cut? Remember all of this, because it’s a reminder. Not a reminder of stupid central banks. Not a reminder that they’re unpredictable. Not a reminder of our own infallibility (although that’s always a good life lesson). No, it’s a reminder that it didn’t really matter. This year has all been about buying the dip. Buy bonds on any dip for yield; same for EM; same for equities. Money had to be put to work. In part this was driven by the central banks’ policies of lower for longer, that’s true: but also because of market structure and how volatility is now volatile itself. So it slams quickly into reverse: fear at its most dreadful turns out to be the point at which you want to go into max greed. We don’t go back to “normal”, we go into uber-risk loving. Volatility eats itself on the downside as well as the upside.

But let’s just look at that US 10 year yield chart… as we have just now had quite a reversal. In fact , we are starting to get closer to reversing the entire 30 year bull market in bonds. Oh but what’s that you say? There’s no good reason to expect a break out of the past 30 years?

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No, there’s just the return of massive political risk premium for the first time in 30 years….
The installation of a potentially fiscally lax new US government…
And the return of inflation, with China PPI emerging from deflation after 5 years…

So as you watch the Fed tonight, there’s one chart to consider. Those pesky dots, which everyone said had become irrelevant. Yes, in part they had, because they kept getting revised down and the dispersion within the Fed kept widening. But to put it into context, with 75bps of hiking hitting the 10 year since Trump was elected, the US yield curve is still only at the 2nd most dovish dot (chart courtesy of the excellent must-follow @toby_n):

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And if Janet Yellen remembers anything of last year, she will no doubt take heart from having seen the same size bond moves as the taper tantrum, but with almost 100% less contagious volatility. So why not embrace the move higher in yields?

This will be the meeting where we look back and realise it all changed. That the central bankers really were irrelevant. That monetary policy was dead. That the die was cast. That buying the dip was delightful while it lasted, but that volatility was about to ramp exponentially higher. That instead of eating itself, it would vomit itself. The periods of excessive risk seeking would be punctuated by excessive risk aversion. Bring on 2017!

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:

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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:

*BOEING SAID TO OFFER TALKS ON AIR FORCE ONE AFTER TRUMP TWEETS
“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.

You’re getting there, say the #BIS

With just under two weeks to go until the holidays begin, and just the hump of the Fed meeting this week to get through, we could all be forgiven for just thinking about crossing the 2016 finishing line intact. That, and gin. Yes, the survival instinct (to which cocktails are integral) is strong. But oh, we would be missing out on the bigger picture. We would be missing out on the panic that is to come. Hence why we should all take a look at the chart below, and then pay significant heed to the latest report from “the only people who called the financial crisis”, the central bank of the world’s central banks, yes the Bank for International Settlements.

So yes, here’s the one chart that keeps Soc Gen’s (in)famous BM-reader Albert Edwards awake at night:
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Albert’s point here is that policy uncertainty is at all-time highs, but the world generally apparently looks alright still. The VIX is happily at the lows of the year as equities make new highs. Even the bond market sell-off has been relatively well contained. The BIS pick this up in their Quarterly Review, pointing out that the recent US bond market sell-off was greater than 99% of all one-day moves in the last quarter-century – “But the jury is still out, and caution is in order. And make no mistake: bond yields are still unusually low from a long-term perspective”.

The BIS warn that this resilience doesn’t mean we will have fewer flash crashes – in fact, quite the opposite.

‘We do not quite fully understand the cause of such unusual price moves … but as long as such moves remain self-contained and do not threaten market functioning or the soundness of financial institutions, they are not a source of much concern: we may need to get used to them.’

Why is this happening? Well the BIS believe it’s to do with that exponentially higher blue line in Albert’s chart. Yes, there’s a heck of a lot more policy uncertainty out there, meaning we have to think more:

‘It is as if market participants, for once, had taken the lead in anticipating and charting the future, breaking free from their dependence on central banks’ every word and deed.’

Hurrah! Huzzah! Blondemoney praises the markets to the heavens if this were true. That’s exactly what we need to be doing, using our judgement to assess the increasing uncertainty, leading to step changes as we re-price for new events.

Oh but if only BM were as sanguine as the BIS. If this paradigm shift is indeed happening, and it’s been bumpy so far, then what happens when we realise that this is happening? That we do need to engage judgement? That politics is non linear? That we can’t build a quant model to tell us the answer?

Then this year will have just been the warning shot. Prepare for many more tremors ahead.

Let Us Know When You Might Start Hiking #ecb

The somewhat ambivalent approach to today’s ECB meeting is a sign of just how dead monetary policy is. We can’t quite leave behind the lower-forever days that consumed us for most of this year, but we face an ECB who might both extend QE and announce when it might be stopping, all at the same time. Even in October, sources were leaking that a taper was being discussed, then last week we got the Reuters story quoting sources:

“Coupled with the extension, there’s a sense that you need to send a signal, also for the hawks, that we will not be in the QE (quantitative easing) business forever,” one of the sources said. “We’re not talking about tapering. We’re talking about a signal.”

OK so not a taper, but at the least it’s an end to QE forever. Or even lower-for-longer. Or even, in fact, the relevance of monetary policy at all, when inflation is coming back. Indeed, the ECB hawks will surely be flagging up one of Draghi’s favourite charts, which shows how inflation expectations have skyrocketed since the start of November, now up at the highs of the year:

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That’s in stark contrast to the deflationary despair of the summer, when this measure hit 1.25%. Now up at 1.68%, that’s heading jolly near to the ECB’s mandated target of “below, but close to, 2%”. And yet the world still acts as if the ECB is locked in a deflationary quagmire death spiral of doom. All the negativity over the Eurozone for the past 5 years casts a long shadow. Sure, there are political risks ahead, and sure, this is just inflation expectations, not actual growth, BUT… the world needs to wake up and come to its senses that the interest rate picture has changed. Even if the ECB were to extend QE and not talk about a taper today, it’s quite evident from the leaked discussions that an end to QE is in sight. Even if they were to cut the deposit rate, wouldn’t that just serve to steepen the yield curve, restoring strength to financials?

QE is a busted flush.

It’s no longer Hands Up if you’re Easing, but Let Us Know when you Might Start Hiking… as shown by RBNZ Governor Wheeler overnight. In his bullish speech he was pretty clear that they are done with cutting interest rates:

‘The latest developments “do not cause us to change our view,” … “We expect monetary policy to continue to be accommodative, and that the projected policy settings will help generate sufficient growth to have inflation settle near the middle of the target range.”’

Interest rate hikes are now creeping into the yield curves of Australia and NZ for the second half of next year.

And so whatever happens today we are at a turning point. The monetary policy emperor really does have no clothes.

Who’s talking to who?

Those of us who sit with our heads immersed in financial markets can sometimes feel as if we are the centre of the world. It all meets here, the hopes and fears of all the years; the conflagration of politics and economics; the constant and ongoing setting of prices. But oh dear, doesn’t it also lead to the worst kind of bubble. The kind of bubble that leads to an arrogance to mock all other bubbles, with City people talking about the Westminster Bubble, or Main Street vs Wall Street, and so on. For a long time it didn’t really matter, as all bubbles were engaged in the biggest of all debt bubbles, and reaping the rewards. When it burst, everyone was hurting at the same time. And everyone relied on the same source for absolution, with central bankers thrust front and centre as our only Obi-Wan Kenobi hope. Only they could deliver the monetary medicine to keep the system going. No wonder that the actions of Mervyn, Ben, Mario and co were followed so closely.

But then something happened. The monetary policy drug went into overdrive, as its effects became less and less powerful. Doing QE? Well I’ll see your QE of government bonds and raise you with equities or mortgage bonds! Fine, I’ll beat that with my Rubicon-crossing into Alice in Wonderland negative interest rates! Stick that in your proverbial pipe and smoke it! Ah, but all that smoking… all that cheap money… all that lower-for-longer that eventually became lower-forever…The medicine kept getting jacked up but the patient still had fundamental problems.

Our dearly beloved unreliable boyfriend Mark Carney tried to point this out with a rather ambitious speech yesterday, arguing:

‘Monetary policy has been keeping the patient alive, creating the possibility of a lasting cure through fiscal and structural operations. It has averted depression and helped advanced economies live to fight another day, so that measures to restore vitality can be taken’

 

Surely no coincidence that just a few months ago, QE was flagged up by the new PM Theresa May for creating further inequality – and now the BOE Governor pops up to argue passionately that it does not. In fact, here’s a ruddy chart to prove it Theresa:

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Yeah! Take that (and party)!

Carney went on to point out that people felt “isolation and detachment” and there were 3 ways to tackle this:

“First economists must clearly acknowledge the challenges we face, including the realities of uneven gains from trade and technology,” he said.
“Second, we must grow our economy by rebalancing the mix of monetary policy, fiscal policy and structural reforms.
“Third, we need to move towards more inclusive growth where everyone has a stake in globalisation.”


Then, almost laughably, he goes on to say that many solutions lay “outside the Bank’s remit”. Oh thanks Mark… we just spent all that time listening to you, with your charts and your bullet points, and your answers… only to say, you personally couldn’t actually do anything about it. Aye here’s the rub. Central bankers are no longer talking to us, the investors. Or even us, the consumers or business people. He’s talking to the politicians. Meanwhile the politicians are trying very hard to talk to The People, but continually getting it thrown back in their face. The careers of Cameron, Clinton, and now Renzi demonstrate that. SOME politicians, of course, are getting it bang on – only many of them are not actually known as politicians (step forward never-held-elected-office-before Donald J Trump). No wonder career politician Tony Blair has popped up to give his opinion, declaring it all very ‘troubling’.

This all matters because it means that the sources usually relied upon to deliver a vision for the future are absent. No more 25bps here or there, a smidge of QE or a taper there – central banks are done. Monetary policy is dead. All we are waiting for with the ECB this week is whether the hawks managed to nobble the doves or do we get a “holding” press conference until they manage it in January? No, the central bankers aren’t talking to us. The politicians don’t know how to talk to us. The populists really aren’t talking to us.

Blondemoney had to smile at the comment from City attendees at a meeting with Chancellor Hammond and Brexit Minister Davis:

“There was quite a blunt warning that politically the Government does not want to be seen to do a deal to favour rich bankers, if it doesn’t comply with Brexit voters’ wishes – that there is more to the negotiation than just the City”

Horror! Telling people that the negotiation might not be all about them! Or what if in actual fact, they were telling the truth, with the emphasis on the words “does not want to be seen to do a deal”. Yes, doesn’t want to be SEEN to do it. Might actually do it, but it won’t look like that. Come on people, this is basic politics! The reason no one is getting it is because we are all like strangers, meeting on a train, speaking different languages. Just as the train is about to career of the tracks and we don’t know if there’s any emergency equipment on board.

Yes, it’s time to look outside of the bubble and figure out who is talking to who and why. Sadly that doesn’t fit into a quant model or a spreadsheet, but good old fashioned human contact might just be the order of the day.