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The Perilous Misperception That Central Bankers Have Mitigated Market Risk
Via Doug Noland's Credit Bubble Bulletin,
This week provided further evidence that the bursting global Bubble has progressed to a critical juncture, afflicting Core markets and economies. Ominously, few seem aware of the profound ramifications – or even the unfolding hostile market backdrop. Even many of the most sophisticated market operators have been caught off guard. There is, as well, scant indication that Federal Reserve officials appreciate what’s unfolding.
I was again this week reminded of an overarching theme from Adam Fergusson’s classic, “When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar German”: throughout that period’s catastrophic monetary inflation, German central bank officials believed they were responding to outside forces. Somehow they remained oblivious that the trap of disorderly money printing had become the core problem.
Dr. Williams’ comment, “It's okay to have the party. It’s okay to get the party going…”, would be laughable if it were not so tragic. At this point, let’s hope the true story of this period gets told. I’m trying: monetary policies for almost 30 years now have been disastrous, a harsh reality masked by epic global market Bubbles.
It’s incredible that confidence in central banking has proved so resilient, though this dynamic no doubt revolves around a single – and circular - dynamic: “whatever it takes” central banking has thus far succeeded in sustaining securities market inflation. And it’s astounding that central bankers at this point are professing “It’s ok to get the party going.” The central bankers’ beloved Party is going to get crashed.
My mind this week also drifted back to a CBB written weeks after the tragic 9/11/2001 attacks. Shock had hit the markets, confidence and the real economy. Officials were determined to stimulate. I recall writing something to this effect: “If stimulus is deemed necessary, please rely on some deficit spending rather than monkeying with the financial markets. Market intervention/manipulation is such a slippery slope.” Back then no one had any idea how far experimental monetary policy could slide into the dark caverns of the deep unknown. Economic, financial, terror, geopolitical – or whatever unanticipated risk that might arise – all-powerful central bankers had an answer that would make things right.
I read with keen interest a Q&A with Jim Grant (Grant’s Interest Rate Observer) reproduced at Zero Hedge. Like others, I’m a big fan of Jim’s writing and analysis.
Question: “So what’s next for the global financial markets?”
Grant Answers: “The mispricing of biotech stocks or corn and soybeans is of no great consequence to financial markets at large. Interest rates are another matter. They are universal prices: They discount future cash flows, calibrate risks and define investment hurdle rates. So interest rates are the traffic signals of a market based economy. Ordinarily, some are amber, some are red and some are green. But since 2008 they have mainly been green.”
It’s apropos to expand on Grant’s comments. Overnight lending rates and Treasury yields are the pillar for a broad range of rates and market yields – at home as well as abroad. Had the Fed, as in the past, restricted its operations – and market distortions – to Treasury bills, I would be much less apprehensive. If the Fed limited its rate-setting doctrine to responding to real economy variables the world would today be a less unstable place.
Instead, the Fed over recent decades nurtured securities market inflation and even turned to targeting higher market prices as its prevailing reflationary policy instrument. Importantly, the Fed and central bankers later resorted to the full-fledged manipulation of broad market risk perceptions. This was a game-changer. Essentially no risk was outside the domain of central bankers’ reflationary measures. As such, audacious markets could Party on, gratified that central bankers had relegated hangovers to a thing of the past.
Key aspects of central bank experimentation over time bolstered global risk assets and, in the end, fomented a historic global financial Bubble. First, by slashing rates all the way to zero, the Federal Reserve and others imposed punitive negative real returns on savers. Part and parcel to the Bernanke Doctrine, rate policies incited unprecedented global flows to equities, corporate bonds and EM bonds and equities. Meanwhile, dollar devaluation spurred historic (“Global Reflation Trade”) speculative excess and leveraging, especially destabilizing for susceptible commodities and EM complexes. Literally Trillions flooded into EM markets and economies, spurring Trillions more of further destabilizing domestic “money” and Credit expansion. Fiasco.
Over-liquefied global markets were conspicuously unstable. Repetitious Fed (and global central bank) responses to fledgling “Risk Off” Bubble dynamics along the way solidified the perception that “whatever it takes” central banks were prepared to fully backstop global securities markets. The summer of 2012 demonstrated to what extent concerted global policy measures would go in response to nascent financial crisis in Europe. Faith in the central bank market backstop became complete in 2013; a bout of market “Risk Off” had the Fed delaying “lift-off” and Bernanke reassuring markets that the Fed was prepared to “push back against a tightening of financial conditions.” It had essentially regressed to the point where a high-risk Bubble backdrop had central bankers telegraphing their willingness to invoke the “nuclear option” (open-ended QE/“money” printing) to blunt incipient market risk aversion.
"Moneyness of Risk Assets" has been fundamental to my “global government finance Bubble” thesis. Policy measures transformed risk perceptions throughout the markets, with global financial assets coming to be perceived as highly liquid and safe stores of wealth (money-like). It may have appeared subtle but it was nonetheless revolutionary. Post-mortgage finance Bubble reflationary measures fomented unprecedented global securities markets distortions. Central bank purchases launched Treasury, agency and global sovereign debt prices to the stratosphere. “Money” flooded into global equities funds, pushing stock prices to record highs. The EFT industry exploded to $3.0 TN, matching the bloated hedge fund industry. The global yield chase coupled with over-liquefied markets ensured record corporate debt issuance. The easiest borrowing conditions imaginable stoked stock buybacks, M&A and other financial engineering
The global financial Bubble evolved to be systemic in nature. So long as global financial conditions remained extraordinarily loose and market prices continued inflating, an expanding global economy appeared to underpin booming securities markets.
The bullish consensus has been convinced that central bankers saved the world from crisis (the “100-year flood”) and securely placed the world recovery on a solid trajectory. I’m sure they have instead fomented catastrophe. Empirical research quantifies central bank impact on market yields in the basis points. Such research would surely also claim QE has had minimal impact on equities prices. Equities are not seen as overvalued. No one it seems sees comparable excesses to 1999 or 2007.
I will make an attempt to concisely state my case. Central banks have convinced market participants that they can ensure liquid (and continuous) markets. Markets perceive that the Fed and global central banks have the willingness and capacity to backstop securities markets. While impossible to quantify, these perceptions have become fully embodied in securities markets around the globe. Importantly, central bank assurances and market perceptions of boundless central bank liquidity are today fundamental to booming global derivatives markets.
Following the 2008 crisis, I expected U.S. and global equities to trade at lower than typical multiples to earnings and revenues. After all, risk premiums would be expected to remain elevated based on recent history. I believed mortgage securities would trade at wider spreads to Treasuries. I thought that, after the market collapse and economic crisis, investors would view corporate debt cautiously. Moreover, I expected counter-party concerns to weigh on derivatives markets for years to come.
I did not anticipate that do “whatever it takes” central banking would overpower the world. Zero rates for seven years and a $4.5 TN Fed balance sheet weren’t in my thinking - because they certainly weren’t in the Fed’s (recall the 2011 “exit strategy”). A $30 TN Chinese banking system would have seemed way far-fetched. Besides, there were indications that Washington had at least learned the crucial lesson of “too big to fail” and moral hazard.
In reality, they learned all the wrong lessons. Traditional central banking was turned on its head. Reckless “money” printing was let loose. Foolhardy market manipulation became the norm. The role played by leveraged speculation and derivatives trading in the 2008 market meltdown was disregarded. And somehow “too big to fail” was transposed from goliath financial institutions to gargantuan global securities markets. And it’s now coming home to roost.
There’s a perilous misperception that central bankers have mitigated market risk. They have instead grossly inflated myriad risks – market, financial, economic, social and geopolitical. As for market risk, Trillions were enticed to global risk markets under false premises and pretense – certainly including specious central bank assurances. And there is the multi-hundreds of Trillions global derivative marketplace that operates under the presumption of liquid and continuous markets. Importantly, central bank manipulation – of market prices and perceptions – fomented the type of excesses that virtually ensures a crisis of confidence.
Individuals can hedge market risk. The broader marketplace, however, cannot effectively hedge market risk. There is simply no one with the wherewithal to shoulder the market attempting to offload risk. Yet central bankers have convinced the marketplace that do “whatever it takes” includes a promise of market liquidity. And this perception of boundless liquidity has ensured a booming derivatives “insurance” marketplace.
There’s a crisis scenario that’s not far-fetched at this point. Fear that global policymakers are losing control spurs risk aversion. The sophisticated leveraged players panic as markets turn illiquid. The Trillions-dollar trend-following and performance-chasing Crowd sees things turning south. Worse still, illiquidity hits confidence in the ability of derivative markets to operate orderly. In short order securities liquidations and derivative-related selling completely overwhelm the market.
It comes back to a momentous flaw in contemporary finance: Markets do not have the capacity to hedge market risk. Indeed, the perception that risks can easily be offloaded through derivative “insurance” has been instrumental in promoting risk-taking. Never have markets carried so much risk. And never have markets been as vulnerable to an abrupt change in perceptions with regard to central banker competence, effectiveness and capabilities.
A Friday morning Bloomberg (Tracy Alloway) article was appropriately headlined “It’s been a Terrible Week for the Credit Market,” included a series of notable paragraph subtitles: “It started in high yield…”, “Glencore made it worse…”; “Then the quarter ended on a down note…”; “And attention turned to investment grade…”; “The pain intensified…”; “What happens next.” A Friday afternoon Bloomberg (Sridhar Natarajan and Michelle Davis) headline read “Credit Investors Bolt Party as Economy Fears Trump Low Rates.” According to Bloomberg, the average junk bond yield this week surged 40 bps to 8.30%, with Q3 junk bond losses the second-worst quarter going back to 2009. This week also saw investment-grade CDS jump to a more than two-year high.
It’s worth noting that the markets were (again) at the brink of disorderly in early-Friday trading. “Risk Off” saw stocks under significant pressure. The dollar/yen traded to 118.68, near August panic lows, before rallying back above 120 late in the day. Treasuries were in melt-up mode. And despite bouncing 4.1% off of Friday morning trading lows, bank stocks ended the week down 1.5%. Underperforming ominously, the 3.8% rally from Friday’s lows still left the Securities Broker/Dealers down 3.1% for the week. Earlier in the week, Glencore worries spurred the first serious “counter-party” concerns in awhile.
October 2 – Reuters (Christopher Condon Craig Torres): “Federal Reserve Vice Chairman Stanley Fischer said he doesn’t see immediate risks of financial bubbles in the U.S., while raising concerns that the central bank’s policy tool kit is limited and untested. ‘Banks are well capitalized and have sizable liquidity buffers, the housing market is not overheated and borrowing by households and businesses has only begun to pick up after years of decline or very slow growth,’ Fischer said… Still, he warned that ‘potential shifts of activity away from more regulated to less regulated institutions could lead to new risks.’ Created a century ago in response to recurring banking crises, the Fed has taken a renewed interest in identifying potential systemic financial threats since the global meltdown of 2008-09…”
Today’s paramount systemic financial threat is not new. Risk is now high for a disorderly – Party Crashing - “run” on financial markets. At the minimum, global markets will function poorly as faith in central banking begins to wane.
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As long as there are fewer and fewer traders, the FED and minions are the major players, then this can go on for a while till the USD cannot be successfully supported by "terror" across the globe. Then it gets worse as we enter WWIII.
The markets would have crashed if it wasn't for Fed put. When the markets do crash, people will blame the Fed
and it will lose all credibility. That is going to be a scary day because all bubbles will pop and the bond market
will cause much more pain than the stock market. The housing market will be cut in half. Better buy some gold
and silver.
There is no market. Therefore there can be no market risk. When price is absolutely controlled by bankers and their cronies, their is risk, but it is not marlet risk. It si a risk that the cronies will change what they are doing.
The FED is finished. Stick a fork in it already.
Playing hot potato with 29 people in the room and 28 hot potatoes.. a lot of people are really going to get burned when the music stops you can't unload risk, when everybody else is also trying to unload.
I've been on this planet for 3 score years and five now, and I have to say, once again, I have never witnessed a more corrupt government/regime than what I see in the United Statest today. That is not to say that it isn't happening elsewhere, because it is, even in the most formerly 'trustworthy' of democracies such as the UK, you have out of control secret spy networks, landed gentry who basically just don't give a damn about anyone but themselves, a broken social support model, zombie banks, terrified citizens, marginalized immigrants, crazy people everywhere. Countries like the UK, the US, France, Saudi Arabia, Israel, Egypt, Turkey, Pakistan (and more) feel perfectly comfortable in allowing, even encouraging terrorism, brutality, assassination and all manner of perverted behavior in the name of 'democracy'. And it isn't even that this is something new, it's been going on for years. What is new is the power of the internet and it's ability (?) to provide news to us 24/7 of anything happening anywhere in the world. And what we see is disgusting. Truly the planet of the Apes.
It all actually depresses the hell out of me. We have been fed nothing more than a line of total bullshit right from our first days on the planet. Brainwashing, in the guise of 'patriotism', the urge to merge, financial slavery and all the other despicable 'social control' mechanisms are being exposed for what they are, nothing more than the government/elites desire to have a somnolent pool of obedient slaves making sure that their position, power, control, influence is never questioned, even when they lead us into the disaster we see today.
This cannot possibly end well. When you see governments everywhere arming themselves to the teeth, violently suppressing dissent, torturing in the name of a 'higher cause', overthowing laws and social contracts that have stood for over a thousand years, you know we have pretty much reached the end. If we can't even follow a few simple steps that were given to us as a guide on how to organize ourselves and conduct our affairs in life (the Constitution), then WTF? Millions and millions of people have lived, and died, trying to achieve a society where we had a fundamental respect for all living things, but it appears that is has all been for naught. If we can't even do the simple things in life then we might as well admit we are nothing more than stupid animals with a peculiar death wish and have at each other.
In the final analysis, Mao was exactly right. Democracy does indeed come out of the barrel of a gun. It was an expression with a poinant double entendre that never ceases to amaze me with it's powerful simplicity.
I'm not sure what you mean by corrupt. If you mean a worthless, feckless Congress, I suppose I agree. But there's been a structural change in our government. Congress may be worthless but it doesn't matter because it being bypassed anyway, unconstitutionally, but few seem to care. The Supreme Court votes outcomes that should be worked out by the (sleeping) Congress.
And the monetary heroin of a government check or the threat of 'not getting theirs' in the future has bought most people off.
So is Obama corrupt? Not to his true ideals. He's getting everything he wants. Seen a recent graph of the national debt? Or a graph of future entitlements (all unfunded)? Even the Democrats I know are stunned - though they look to be the last to be wising up.
But it doesn't matter anyway because no one's going to do anything about it anyway. This is the perfect example of the frog (me and you) in the pot being brought very slowly to a boil. He (we) never jumps out.
Again...the President is succeeding beyond his wildest dreams (check that national debt chart again!) as he presides over a lazy nation.
Just to add more vitriol to the fire...
I repeat...
We know there is no public market. It is the Fed Fuck's market now.
We all know the Fed Fucks, through market manipulators (pick one) are stair stepping their 'markets' down vs. permiting an uncontrolled crash.
We all know that the Fed Fucks are using manipulated government statistics to show weaker economic health to help throttle the equities markets down.This gives the Fed Fucks an escape from raising interest rates and further sinking this moribund economy into a deeper recession, or worse.
We all know the Fed Fucks do not want to be blamed for another recession or mismanagement of the economy, again... They also know they do not have 100% control either. And this is what keeps the Fed Fucks awake at night. The sooner we exposed these fucks and the fact that there are no public markets, and drive the public to losing all faith in the Fed's markets, the sooner we will take the Fed Fucks out of the game and get back to capital markets normalcy.
Off with their fucking heads already
A. the international banks own the Federal Reserve, both literally and figuratively. So, when you are talking about the Fed, you are simultaneously talking about JP Morgan, Goldman Sachs and the rest.
B. There is only risk in a real market. In a fake market, such as we have now, all we have is policy. If the market goes up, then it is policy. If the market goes down that is policy as well.