2012: The Year Of Hyperactive Central Banks
Back in January 2010, when in complete disgust of the farce that the market has become, and where fundamentals were completely trumped by central bank intervention, we said, that "Zero Hedge long ago gave up discussing corporate fundamentals due to our long-held tenet that currently the only relevant pieces of financial information are contained in the Fed's H.4.1, H.3 statements." This capitulation in light of the advent of the Central Planner of Last Resort juggernaut was predicated by our belief that ever since 2008, the only thing that would keep the world from keeling over and succumbing to the $20+ trillion in excess debt (excess to a global debt/GDP ratio of 180%, not like even that is sustainable!) would be relentless central bank dilution of monetary intermediaries, read, legacy currencies, all to the benefit of hard currencies such as gold. Needless to say gold back then was just over $1000. Slowly but surely, following several additional central bank intervention attempts, the world is once again starting to realize that everything else is noise, and the only thing that matters is what the Fed, the ECB, the BOE, the SNB, the PBOC and the BOJ will do. Which brings us to today's George Glynos, head of research at Tradition, who basically comes to the same conclusion that we reached 2 years ago, and which the market is slowly understand is the only way out today (not the relentless bid under financial names). The note's title? "If 2011 was the year of the eurozone crisis, 2012 will be the year of the central banks." George is spot on. And it is this why we are virtually certain that by the end of the year, gold will once again be if not the best performing assets, then certainly well north of $2000 as the 2009-2011 playbook is refreshed. Cutting to the chase, here are Glynos' conclusions.
- 2012 will be characterised by strong central bank activity and interventions
- Major central banks will continue to support governments through quantitative easing type policies [so much for 'not political']
- Boom/Bust economic cycles will be fostered which are shorter in duration and could hold greater amplitude
- Central Bank activity will not necessarily improve core economic fundamentals [contrary to what CNBC will tell you every single day]
- Financial markets will impress in H1 despite weak underlying economic fundamentals [contrary to what CNBC will tell you every single day]
- Sovereign bond markets will in the main be supported and yields will be driven lower at least through H1 2012
- Equity markets will enjoy the support of investors on account of valuations relative to money markets and bonds
- Commodity prices will rise in US Dollar terms as currency debasement policies are followed
- Asset price reflation will be a central theme for the year
Translation: inflationary concerns be damned - after all it is precisely inflation that central banks need. And to get it they will risk much more inflation. Yes, the dreaded hyper word as well. Because unfortunately, the only real backstop to the threat of global hyperinflation, Germany, recently threw in the towel as we described in the appropriately titled "Das Kapitulation" [sic]....And people wonder why China is buying gold hand over fist.
More from (the appropriately titled) Tradition:
Since the crash of 2008, central banks have been called on to do extraordinary things. The policy stances that they have adopted would never be adopted in any normally functioning economy. Yet given the length of time required to reform a fiscus and the inclination to utilise government as a vehicle to spend an economy back into shape (under pretence of investing) has meant that central banks have been left in the undesirable position of having to use monetary means with which to intervene in order to prevent a repeat of a massive and deep recession if not depression. Using those terms now may sound melodramatic but they unfortunately still apply.
Monetary policy has become increasingly important and so too has the need to understand it. Following the money that is printed up has become an arduous but important task and helps one understand the consequences of this central bank intervention. Increased money supply matters and the injection of such funding cannot be ignored. To ignore such factors would also translate into investors misinterpreting the financial environment in which they operate and how it is possible that weak economic fundamentals notwithstanding, financial markets can still post record highs and perform better than expected in 2012. It is this very dynamic which was largely ignored in 2009 and 2010 and which led many investors to believe that markets would not perform as well as they did.
Central bank behaviour in 2011
What was remarkable about 2011 was the lack of outright monetary intervention by the central banks. Some may argue that the effects of policies implemented in the past were still exerting influence. However if they were, they were not overtly obvious in the behaviour of sovereign debt markets. US banks may have had large quantities of excess reserves, but the Fed resisted the temptation to embark on Fresh QE, the BoE indicated that another round of quantitative easing would be initiated, but this only became official towards the end of the year and the effects of those actions would ultimately only become evident in 2012. The ECB was prevented from entering the sovereign bond market through EU Treaties and chose instead to persist with the line that ECB President Trichet adopted, namely that the crisis in the eurozone was driven by sovereigns and that only sovereigns had the power to resolve these issues. This changed in December when the ECB did an about-turn and began to intervene more significantly in the eurozone economy. Again the effects of this policy reversal would only become evident in the final weeks of 2011 and would set the stage for an impressive start to 2012 for many eurozone sovereign debt markets.
Further afield, 2011 was also characterised by the Chinese monetary authorities trying to deflate a property bubble whilst India also underwent some monetary tightening. Even emerging markets such as Brazil and Turkey that were used to some fairly strong growth in credit extension and money supply chose to adopt a tighter approach to monetary policy. All in all, 2011 can be characterised by less active central banks that chose to allow the economies to unravel some of the excesses of the past. Had they persisted with such a stance, the start of 2012 could have looked very different. The reality however is that they have not. Quite the contrary.
Central banks have learned that taking to the side lines holds consequences. Given the massive and rapidly growing indebtedness of most of the world’s largest economies (read governments), it was became clear that the markets most vulnerable to this fiscal dynamic, namely the sovereign debt markets, reflected the effects of a wholesale rotation back to safety and the shunning of debt markets which held the highest risk. The absence of central bank demand for sovereign debt was palpable. Those economies without central bank assistance, namely the eurozone economies became the most vulnerable were pushed to the margin and began to fail. Bond yields of many major eurozone economies started to reflect risk aversion. The highly indebted periphery began to suffer the indignity of speculation against their governments and their bond yields soared. With each passing day of inaction on the part of the central banks, sovereign debt yields progressively marched higher to even more uncomfortable levels with speculation in the market mounting that economies such as Spain, Italy and even the likes of Austria and France were on the path of bankruptcy.
As it became increasingly clear that central bank demand for sovereign debt was absolutely vital in buying governments the time they need to restructure themselves, so the central banks began to change their approach back to something more accommodative and supportive of the global economy. The BoE was the first to indicate that they would be embarking on a fresh round of quantitative easing, the ECB then eventually found a way to circumvent EU treaty restrictions by engineering an environment whereby the commercial banks would do all the sovereign debt buying, the Fed has hinted increasingly that it would step back in to the economy on the grounds that the current economic upswing might not be sustainable, whilst a host of emerging market central banks including China, India, Brazil and Turkey are now adopting a far more accommodative stance to ensure soft landings in those economies.
Central Banks in 2012
Whether we believe that the reasons behind the central bank interventions are a fresh effort to boost growth directly or whether one believes that the central banks have adopted an ultra-accommodative stance in order to boost demand for sovereign debt and reduce the risk of a major sovereign collapse, the result is the same. Namely, that the central banks have chosen to prioritise growth and investor confidence above inflation. Increasingly one gets the sense that inflation is being seen as a welcome distraction given the current economic backdrop where the underlying imperative is for asset prices to deflate.
Whereas in 2011 we noted that the lack of Fed, BoE and ECB bond purchases resulted in a crowding out of the debt markets of economies with worrying debt fundamentals, 2012 will be the year when that view is given added credence. In just two short months when the BoE and ECB openly announced their monetary efforts, sovereign debt markets of highly indebted markets or those of emerging markets have begun to rally and rally extremely strongly. With those major central banks confirming that they will be more active in 2012 and given the coincidence or not, that they are acting together, the reality is that the dearth of monetary intervention in 2011 will be replaced by a flood of capital and funding.
In assessing the consequences of such actions we would need to look back to 2009 and 2010 to understand the impact of strong monetary interventions on the financial markets. We understand now that quantitative easing whether it be through the Fed’s methods or those of the ECB can have very strong asset price inflationary effects. We have already enjoyed a taste of this in recent weeks. Markets that have rallied include:
1. Equity markets
2. Sovereign debt markets
3. Commodity prices
4. Emerging market assets
5. And as a consequence EM currencies
In the event that the Fed does indeed introduce another round of QE in the order of a further USD500bn, and the BoE continues to build its balance sheet to levels approaching GBP400bn from the current GBP275bn at a time when the ECB partakes in more of the same kind of monetary policy aimed at engineering an attractive internal carry trade to help banks and sovereign debt, asset prices in general hold the potential to rally significantly further on account of the monetary stimulation and the boost to sentiment which will follow.