January 24, 5:00 pm EST
With two big central bank meetings behind us this week, and the Fed on deck for next week, let’s remind ourselves of where the global central banks stand, more than 10 years after the crisis.
There’s one thing we know, following the events of the past decade: The global central banks will do “whatever it takes” to preserve stability and manufacture economic growth. As long as global economies remain interconnected (which they are), this is the script they (global central banks, in coordination) will follow. They crossed the line long ago. There’s no turning back.
So, with all of the continual talk in past years about another big shock or “shoe to drop,” people have failed to acknowledge the key difference between the depths of the financial crisis and now. Back then, we didn’t know how policymakers would respond. That’s a lot of uncertainty. Now we know. They will change the rules when they need to. That removes a lot of uncertainty.
With this in mind, remember on January 4th, in response to an ugly December for the stock market, the Fed marched out Bernanke, Yellen and Powell to walk back on the tightening cycle. For a world that was expecting four rote rate hikes this year, that was an official response – effectively easing, intermeeting.
Next up, the Bank of Japan. They met this week. With the ECB now done with QE, the BOJ is now the lone global economic shock absorber. Not only have they been executing on their massive QQE plan since 2013, in 2016 they crafted a plan that gave them greenlight to do unlimited QE as long as their 10-year government bond yield drifted above the zero line. So, as global yields pull Japanese yields higher, the BOJ responds by buying bonds in unlimited amounts to push it all back down. That has been the anchor on global interest rates. And given that they see inflation continuing to run well below their target of 2%, through 2020, the BOJ will be printing for the foreseeable future (remaining that anchor on global interest rates).
What about Europe? A few months ago, some thought the ECB might be following the Fed footsteps — with a first post-QE rate hike by the middle of this year. Today, Draghi put that to bed, saying risks are now to the downside, and that the market has it right pricing in a rate hike for next year – assuming all goes well. But Draghi also wants us to know that the ECB stands ready to act if the economy falters (i.e. they can/will go the other way).
So, for perspective on where the global economy stands, we still have central banks pulling the levers to keep it all together. That’s why Trump’s big and bold fiscal stimulus and structural reform was/is absolutely necessary. And that’s why the rest of the world will likely have to follow the U.S., with fiscal stimulus, if we are to ultimately and sustainably put the crisis period behind us.
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October 4, 5:00 pm EST
For perspective, the Fed has now moved 8 times off of zero. The leaves the benchmark (short term) rate set by the Fed at 2-2.25%, still well below long-term average rates. And that leaves the market determined (longer term) interest rate, just below 3.25%, still well below the long-term average. With that, rates are still low. In fact, if we took the record low in the 10-year yield, set in July of 2016, and applied the Fed’s 200 basis points of hikes, we would have a 10-year of 3.34%. We are still south of that. I would argue at current levels, the interest rate market is finally pricing in sustainable economic recovery (pricing out risks of another post-economic crisis shock/slump).
Now, when rates are on the move, people immediately start talking about debt service. On that note, consumers and companies are in as good a financial position as they’ve been in a very long time (record high household net worth, record profits) . Household debt service ratios are at record lows.
Bottom line, the move in rates is a growth story, not a crisis story. We have 3%+ economic growth, with low inflation and solid employment. We may have finally returned to the level of trust and confidence in the economy that fuels “animal spirits.”
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September 28, 5:00 pm EST
Italy first, means EU second. And that puts the future of the European Union and the European Monetary Union in jeopardy. Today, the new government made that clear by rejecting EU fiscal constraints, in favor of running a bigger deficit spending.
This puts the game of poker the European Union has been playing since the financial crisis erupted, front and center (again).
As we discussed back in May, this story is looking a lot like Greece, which used the threat of leaving the euro as leverage to negotiate some relief from austerity and reforms. It was messy, but it gave them a stick, in a world where the creditors (the ECB, Eurogroup and IMF) had been burying the weak economies in Europe in harsh austerity since the financial crisis.
As the third largest euro zone constituent, Italy brings a lot more leverage in negotiating, in this case, the EU rulebook. We may see this all result, finally, in a relaxing of the fiscal constraints that have suppressed the economic recovery in the euro zone in the post-Great Recession era. And Italy’s pushback may lead the way for a euro-wide fiscal stimulus campaign — following the lead of Trumponomics.
A better economy has a way of solving a lot of problems. And Europe has a lot of problems.
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June 13, 5:00 pm EST
Watching the media and expert community digest the Fed decision is always interesting.
They are all programmed to home in on the worst-case scenario. It’s very similar to the way they parse politics.
In this case, the Fed projected an extra rate hike this year. They were projecting three hikes for 2018. Now they are projecting four hikes for the year (two of which are now in the rear-view mirror). Why an extra hike? Is it because they want to disrupt the recovery and undo all of their efforts of the past decade to manufacture that recovery? No. It’s because they think the economy is good! In fact, Powell (the Fed Chair) said “the main takeaway is that the economy is doing very well.”
And when asked about the impact of tax cuts, he said, we’ve yet to see the benefits. But, it should “provide significant support to demand over the next three years … encourage greater investment … and drive productivity.” This is exactly what we stepped through last week in my Pro Perspective notes (here). We laid out the components of GDP (consumption, investment, government spending and net exports) and we talked about the setup for positive surprises feeding into an economy that’s already running at near 3% growth — because pro-growth policies are just beginning to show up in the data!
With that, it should be no surprise that the Fed feels more comfortable telegraphing another hike, from what is still very low levels of interest rates.
Now, what is the negative scenario the pundits have been harping on? The yield curve. With the Fed gradually walking up short term rates (rates they set), the benchmark market interest rates (namely the 10-year government bond yield) has been soft. That creates yield curve flattening, which gets the bears excited that a yield curve inversion could be coming (a good historical predictor of recession).
Why is the 10 year yield soft? As we’ve discussed, the two major central banks that are still in the QE game have been anchoring longer term interest rates through their outright purchases of global government bonds (including lots of U.S. Treasuries, which keeps a cap on yields).
On that note, we have the ECB tomorrow. And the Bank of Japan will meet on monetary policy tomorrow night. The trajectory of global monetary policy is UP. And the more the Fed does, the more it forces that timeline elsewhere in the world to follow the Fed’s path on normalizing rates. The ECB will be following the Fed normalization path soon. And the Bank of Japan will be last. And when we get hints that it’s coming sooner rather than later, the yield curve will start steeping, and the bears will have a very hard time justifying their “sky is falling” view.
May 16, 5:00 pm EST
We’ve talked about the stock market’s discomfort with the 3% mark in rates. People have been concerned about whether the U.S. economy can withstand higher rates–the impact on credit demand and servicing. That fear seems to be subsiding.
But often the risk to global market stability is found where few are looking. That risk, now, seems to be bubbling up in emerging market currencies. We have a major divergence in global monetary policies (i.e. the Fed has been normalizing interest rates while the rest of the world remains anchored in emergency level interest rates). That widening gap in rates, creates capital flight out of low rate environments and in to the U.S.
That puts upward pressure on the dollar and downward pressure on these foreign currencies. And the worst hit in these cases tend to be emerging markets, where foreign direct investment in these countries isn’t very loyal (i.e. it comes in without much commitment and leaves without much deliberation).
You can see in this chart of the Brazilian real, it has been ugly …
Something to watch, as a lynchpin in this EM currency drama, is the Hong Kong dollar. Hong Kong has maintained a trading band on its currency since 2005 that is now sitting on the top of the band, requiring a fight by the central bank to maintain it. If they find that spending their currency reserves on defending their trading band is a losing proposition, and they let the currency float, then we could have another shock event for global markets, as these EM currencies adjust and their foreign-currency-denominated debt becomes a default risk. This all may force the rest of the global economy to start following the Fed’s lead on interest rates earlier then they would like to (to begin closing that rate gap, and avoid a shock event).
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December 19, 4:00 pm EST
Remember, the Fed met last week and hiked rates for the third time this year, and the fifth time in the post-crisis hiking cycle. But as we discussed, the big event for interest rates wasn’t last week, it’s this week.
The Bank of Japan meets on Wednesday and Thursday. Japan‘s policy on pegging their 10-year yield at zero has been the anchor on global interest rates (weighing on global interest rates). When they signal a change to that policy, that’s when rates will finally move – and maybe very quickly.
With that in mind, we have the stock market continuing to climb north of +20% on the year. Economic growth is going to get very close to 3% for the full year of 2017, and yet the benchmark longer term interest rates determined by the market are unchanged for the year. The yield on the 10 year Treasury is 2.43% this morning (ticking UP today). We came into the year at 2.43%.
Again, this is the flattening yield curve we discussed last week. For a world that is constantly looking for the next potential danger or signal for doom, the flattening of the yield curve has been the latest place they’ve been hanging their hats (as what they believe to be a predictor of recession). But those people seem happy to assume this yield curve indicator is driven by the same behaviors that have led to recessions in past economic periods, ignoring the unprecedented and coordinated global central bank manipulation that has gotten us here and continues to warp the interest rate market.
So now we have the Fed, which has been moving away from emergency policies. The ECB has signaled an end to QE next year. And the Bank of Japan is next in line — it’s a matter of when.
So how do things look going into this week’s meeting? We know the architect of Japan’s economic reform plan, Prime Minister Shinzo Abe, has just followed the American fiscal stimulus movement with a corporate tax cut of his own, but only for companies that will start raising wages for their employees. He said today that Japan is no longer in a state of deflation. The head of the Bank of Japan has said the economy is in “very good shape.” And that they would consider what is the best level of rate targets to align with changes n the economy, prices and financial conditions. The recent Tankan survey showed sentiment in the manufacturing community hitting decade and multi-decade highs.
But inflation continues to undershoot in Japan, as it is in the U.S. Japan is targeting a 2% inflation rate and is running at just 0.8% annualized.
So it’s unlikely that they will give any signal of taking the foot off of the gas this week. But that signal is probably not far off — maybe in January, after U.S. tax cuts are in effect. What does that mean? It means our market rates probably make an aggressive move higher early next year (10s in the mid 3s and rates on consumer loans probably jump 150 to 200 basis points higher).
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December 2, 2017, 4:00 pm EST
We have big central bank meetings this week. Let’s talk about why it matters (or maybe doesn’t).
The Fed, of course, has been leading the way in the move away from global emergency policies.
But they’ve only been able to do so (raising rates and reducing their balance sheet) because major central banks in Europe and Japan have been there to pick up where the Fed left off, subsidizing the global economy (pumping up asset prices and pinning down market interest rates) through massive QE programs.
The QE in Japan and Europe has kept borrowing rates cheap (for consumers, corporates and sovereigns) and kept stocks moving higher (through outright purchases and through backstopping against shock risks, which makes people more confident to take risk).
But now economic conditions are improving in Europe and Japan. And we have fiscal stimulus coming in the U.S., into an economy with solid fundamentals. As we’ve discussed, this sets up for what should be an economic boom period in the U.S. And that will translate into hotter global growth. So the tide has turned.
With that, global interest rates, which have been suppressed by these QE programs, will start moving higher when we get signals from the key players, that an end of QE and zero interest rates is coming. The European Central Bank has already reduced its QE program and set an end date for next September. That makes the Bank of Japan the most important central bank in the world, right now. And that makes the meeting next week at the Bank of Japan the most important central bank event.
Let’s talk a bit more about, why?
Remember, last September, the Bank of Japan revamped it’s massive QE program which gave them the license to do unlimited QE. They announced that they would peg the Japanese 10-year government bond yield at ZERO.
At that time, rates were deeply into negative territory. In that respect, it was actually a removal (a tightening) of monetary stimulus in the near term — the opposite of what the market was hoping for, though few seemed to understand the concept. But the BOJ saw what was coming.
This move gave the BOJ the ability to do unlimited QE, to keep stimulating the economy, even as growth and inflation started moving well in their direction.
Shortly thereafter, the Trump effect sent U.S. yields on a tear higher. That move pulled global interest rates higher too, including Japanese rates. The Japanese 10-year yield above zero, and that triggered the BOJ to become a buyer of as many Japanese Government Bonds as necessary, to push yields back down to zero. As growth and the outlook in Japan and globally have improved, and as the Fed has continued tightening, the upward pressure on rates has continued, which has continued to trigger more and more QE from the BOJ – which only reinforces growth and the outlook.
So we have the BOJ to thank, in a pretty large part, for the sustained improvement in the global economy over the past year.
As for global rates: As long as this policy at the BOJ appears to have no end, we should expect U.S. yields to remain low, despite what the Fed is doing. But when the BOJ signals it may be time to think about the exit doors, global rates will probably take off. We’ll probably see a 10-year yield in the mid three percent area, rather than the low twos. That will likely mean mortgage rates back well above 5%, car loans several percentage points higher, credit card rates higher, etc.
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October 31, 2017, 4:00pm EST
Let’s take a look today at what fiscal stimulus might do to inflation.
The central banks have been able to boost asset prices. They’ve been able to restore stability so that people felt confident enough to hire, spend and invest again. But the scars from over-indebtedness have left demand weak. And because of that, despite the recovery of the unemployment to under 5%, the quality of jobs haven’t returned. And, therefore, the leverage to command higher wages hasn’t been there. That’s been the missing piece of the recovery puzzle.
And with that, we’ve had an ultra-low inflation recovery. That sounds great (low inflation).
But inflation at these low levels has had us (through much of the past decade) teetering on the edge of deflation. That’s bad news.
Among the many threats throughout the crisis period, a deflationary spiral was one of the Fed’s most feared. Central bankers can fight inflation (by raising rates). But they can’t fight deflation when consumer psychology takes over. When people hold on to their money thinking things will be cheaper tomorrowthan they are today, that mindset can bring the economy to a dead halt. It’s a formula that can become irreversible.
And that’s what has kept the Fed (and global central banks) sitting at ultra-low levels of interest rates – to keep the recovery momentum moving so that they don’t have to fight a deflationary spiral (as they have in Japan, unsuccessfully, for two decades).
Now, enter fiscal stimulus. We’re getting fiscal stimulus into an already tight employment market.
Real wages (employee purchasing power) has barely budged for two decades. Introducing big tax cuts and government spending into an economy that has low unemployment and the best consumer credit worthiness on record should pop demand. And that should finally give us some wage growth – maybe bigwage growth.
All of the inflationists that thought QE was going to cause hyper-inflation were wrong – they didn’t understand the severity and breadth of the crisis. Now, after global unlimited QE has barely moved the needle on inflation, the inflation hawks have been lulled to sleep. It may be time to wake them up.
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