We have been discussing the widespread belief in "the narrative of central bank omnipotence" for a number of months (here and here most recently) as we noted "there are no more skeptics. To update Milton Friedman’s famous quote, we are all Bernankians now." So when Saxobank's CIO and Chief Economist Steen Jakobsen warns that "the mood has changed," and feedback from conference calls and speaking engagements tells him, there is a growing belief that the 'narrative of the central banks' is failing, we sit up and listen.
Via TradingFloor.com's Steen Jakobsen, CIO & Chief Economist Saxobank,
The Mood Sours
I have had several macro conference calls and speaking engagements over the course of this week – a few takeaways:
1. The mood has changed – See the “confidence index” from T Theory below for data. The driver in my opinion is the gradual acceptance of disinflation/deflation – as Albert Edwards has been pointing out and as Russel Napier has substantiated that when inflation gets low enough it becomes a problem for risky assets. (Edwards–Napier)
2. There is growing belief that the “narrative of the central banks” is failing. We've had such low yields for so very long now that it's becoming an issue. I've discussed this with several of you and the consensus opinion is that the European Central Bank's Mario Draghi lost out with his latest “wide in scope, small in size” programme; that the Bank of Japan looks like a deer caught in the headlights; and most importantly, Fed chief Janet Yellen and her team are doing a poor job in communicating their message.
There is even open resentment of Yellen as a female chair. I don’t condone any of the Fed's policies, but I firmly believe Yellen is misunderstood. She is more dovish than the market can figure out and in contrast to her predecessors, she allows more room for the opinions of fellow board members. This is why we are seeing Stanley Fischer being a new and much-improved voice for the Fed, as is also the case with William Dudley. Further, Yellen is considerably better than both Alan Greenspan and Ben Bernanke in terms of understanding the mechanics of the Fed and the economy.
Janet Yellen is far more of a dove than people realise. Photo: Federal Reserve
Finally on the Fed – I never understood how the market could pay so much attention to regional presidents. They are politicians, representing either specific economic agendas relative to their own region or are subscribers to some specific economic theory. Let’s hope the “dots” die soon as they are without doubt the most useless pieces of information ever. (You can reach a specific growth forecast from many angles being one of the issues.)
3. Central banks are now concerned about the velocity of foreign exchange moves (ECB and BoJ) and the Fed is explicitly worried about the impact on future US growth. This major change – a vocal change as often before initiated by New York Fed’s Dudley (September 21, 2014) and confirmed by Fed Minutes this week: "Officials at the Federal Open Market Committee’s Sept. 16-17 meeting warned that the stronger dollar may hamper exports, and said the economy could be hurt by a global slowdown." (Bloomberg)
Of course 95% of Wall Street and 98% of all hedge funds remain long US dollar as it’s an island of strength – my model, however, disagrees, as seen below. The vertical line is the present...
My only call (since Q4-2013) remains that global yields (G10) drop to all-time lows – and in this final phase will be lead to the US 10-year going to 1.5% and the 30-year to 2.5%. This creates a derivative trade which is that the US dollar's strength is about to top. There is a significant possibility of the US dollar retesting recent highs.
However, central banks, the momentum of the US economy, disinflation trends and a global geopolitical environment which sees the US lose power week by week, are all signs, although still early, of changes to the outlook. The world – growth-wise – does not work with a strong US dollar. Asia is linked and is suffering…
4. It’s often “too easy” to find negative charts after big down move, but I think these three represent more than a day or two of sell-offs...
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I’m calling a top in the Narrative of Central Bank Omnipotence because it has, in fact, reached its asymptotic limit of influence and belief.
It’s a top because the cracks are starting to show and widen. A Narrative architecture can sustain amazing structures, much like the flying buttress allows Gothic cathedrals to soar, but ultimately it can only bear so much weight. Draghi’s language last Thursday was sloppy. His pitch was uncharacteristically poor as he sang his lullaby to the Red King. I think he’s bitten off waaaay more than even he can chew, a point I’ll review at length next week. As for the US, the Central Bank Omnipotence Narrative is actually counterproductive for equity market price levels at this point. Because we are such well-trained monkeys, we act by reflex today to buy-buy-buy whenever a headline of Central Bank activism surfaces, but the training starts to work the other way when the tightening starts in earnest and the Fed reserves hang out there unresolved, like the mother of all lead balloons draped around the long end of the curve. Remember what an inverted yield curve looks like? Ain’t a pretty sight. But draining the reserves could look even worse. Damned if you do. Damned if you don’t. And the equity market caught in the middle.
It’s a top because – like a Ministry of Industry or a Ministry of Culture – a Ministry of Markets and its dirigiste control of the human animal’s social behavior ultimately fails. Maybe not a failure in the sense of apocalypse and ruin (although sometimes), but a failure in the sense that The Next Big Thing never comes out of a Ministry. They have their successes, sure … some grand program or triumphant announcement … but they’re only successes because we are TOLD they are successes. Since when has a Ministry of Culture sparked great art? Since when has a Ministry of Industry sparked great commercial advancement? Ministries are well-meaning. Ministries are the darlings of the professional intelligentsia that controls the organs of the State and Media. Ministries are wonderfully effective instruments of social control. But neither art nor commerce nor investment comes well from on high.
It just doesn’t stick. The most powerful ideas in human history always come from below, not from above, and markets (and elections and revolutions) are the transmission mechanism of the idea engine. Watch out above!
An inflection point in the market Narrative doesn’t alter market price levels directly. It alters the informational structure of markets (for a refresher course on what I mean, see “Through the Looking Glass”). It alters the market’s response pattern to future signals and events. That’s why I think it’s silly to predict end of year S&P 500 levels or engage in any such crystal ball gazing, because I have no idea what will happen next. But whatever pops out of the woods next (and somehow I doubt the global economy is walking down a primrose path), I think that using an Epsilon Theory perspective based on information theory and strategic behavior can help me react quickly and appropriately, which is what I mean by Adaptive Investing.
I don’t know what the catalyst for The Next Big Thing will be, although I have my suspicions. Maybe it’s a realignment election in Italy or the US. Maybe it’s China saying whatever the Mandarin equivalent of no mas might be. Maybe it’s a liquidity seizure in the repo market or some other unanticipated structural market failure. But whatever it is, we’re no longer at a point where additional State intervention can claim additional Narrative firepower. It’s like buying a stock that has no short interest and where all the sell-side analysts are rabidly positive. No thanks! Just as a short seller today is the marginal buyer of your stock tomorrow, so is the skeptic today the convert tomorrow. There are no more skeptics. To update Milton Friedman’s famous quote, we are all Bernankians now. Or rather, we all have to profess our Bernankian faith through our market behaviors even as we privately yearn for the Old Gods of greed and fear and the Old Languages of value and growth. And that’s the inflection point.