With economic analysis no longer a relevant consideration in the New Normal as Jeff Gundlach explained yesterday, the only real question since the advent of global QE, first in the US, then in Japan, soon everywhere else, is when does the Fed stop. And not just Taper, because while the Fed may slow down the flow pace of liquidity injection one month, it will promptly reaccelerate it just after when risk tumbles, but the structural, and terminal end of QE.
Our previous speculation on this topic has focused on the eventual increase in interest on reserves, both in a rising rate environment and simply from perpetuation of reserve expansion, as well as the Fed's relentless monetization of duration risk: recall that Bernanke owns 30.5% of all 10 Year equivalents currently, a number which is set to hit 100% by 2018, but which will break the bond market long before that. In brief: open-ended QE is anything but, at least until the Fed breaches it mandate and start "monetizing" outright risky assets just like the BOJ - a step it very well may be forced to engage in.
So to supplant the critical perspective on when/if the Fed finally pulls the plug we present the following observations by Pimco's Richard Clarida who looks at the end of QE from a more conventional macroeconomic perspective. His thoughts are presented below in their entirety.
But before absorbing the full analysis, here is Clarida's punchline distinguishing between those who believe the Fed is doing something positive, versus those who, correctly, understand it is Ben Bernanke's own fault for clogging up the monetary transmission mechanism, and for de facto "breaking the market" which is now - like a liquidity-addicted drug addict - impossible to visualize a world in which the Fed does not provide zero-cost training wheels from here until eternity:
QE detractors... see something quite different. They see QE as not responding to the collapse in the money multiplier but to some extent causing it. In this account QE – and the flatter yield curves that have resulted from it – has itself broken the monetary transmission mechanism, resulting in central banks pushing ever more liquidity on a limper and limper string. In this view, it is not inflation that’s at risk from QE, but rather, the health of the financial system. In this view, instead of central banks waiting for the money multiplier to rebound to old normal levels before QE is tapered or ended, central banks must taper or end QE first to induce the money multiplier and bank lending to increase.
This is absolutely spot on, but unfortunately this "liquidationist" path to fixing a problem that should have been addressed five years ago is now a dead end, as Bernanke knows he can not end QE in some interim phase without achieving (runaway) inflation or all that he has "accomplished" for the market, if not the economy will be undone. Even if, ironically, the market crash that results, would be just the debt-liquidating economic catharsis the developed world has been begging for since the advent of central planning.
Oh well. Let's just hope this time is different.
Anyway, without further ado, here is PIMCO on Reflation in the Balance
- Four of the world’s major central banks are now “all in” when it comes to ballooning their balance sheets in correlated, if not coordinated, efforts to achieve escape velocity in their economies.
- In accounting for the impact of quantitative easing on two key balance sheets, we are able to interpret, monitor and calibrate the programs currently in place. This in turn can help us prepare portfolios if – or when – sentiments and inflation expectations shift.
“It is sometimes better to study a balance sheet than it is to believe a model”
Rudiger Dornbusch, 1980
With the Bank of Japan’s recent “shock and awe” decision to double down on quantitative easing (QE), four of the world’s major central banks – the BOJ, the Fed, the Bank of England and the Swiss National Bank – are now “all in” when it comes to ballooning their balance sheets in correlated, if not coordinated, efforts to achieve escape velocity in their economies.
These programs are enormous and untested, and they risk serious unintended consequences even if they ultimately succeed in reflating these economies. QE is controversial, but it’s also not well or widely understood – primarily because there is no agreed upon model for how it works. And theoretical economic models themselves can sometimes get in the way, obfuscating instead of illuminating.
Nominal GDP growth
While I have focused on the experience of individual countries, there are potential global externalities, benefits and costs to QE that are also important. As of now, commodity prices and the price of gold do not suggest that markets are worried about the global inflation consequences of QE. But only two years ago, when there was trillions less of QE in the global financial system, they were. This reminds us that sentiment and inflation expectations can shift. If and when they do, the exit dynamics from this very crowded global QE trade will likely be more complex than they may appear: nasty and brutish for those who are short.