Reminding us of what McKinsey reported over a year ago, namely that the world never deleveraged after the financial crisis, Citi's Hans Lorenzen released a fascinating presentation today discussing the "invincible" stock rally, and pointing out its Achilles heel, which happens to be the thing that made it possible in the first place: central banks.
As the first charts below show, the permissive factor that allowed the world to "emerge" from the financial crisis and the global recession, was a surge in debt, which on a consolidated basis is above 360% of GDP in all five select developed regions. The chart on the right shows that while private sector releveraging has been slow, it has been drowned out by a historic surge in public sector debt.
What made this coordinated global releveraging possible? Central banks of course, who have bought over $10 trillion in public (and recently private) sector debt in the past decade, and between the world's six largest central banks they now collectively own securities amounting to 40% of the world's GDP.
However, it is this same unprecedented central bank balance sheet expansion that is now the biggest threat to not only the global recovery and ongoing attempts to stimulate the much needed reflation (if only to inflate away the world's debt load), but also to capital markets around the globe.
Which bring us to what may be the scariest chart for central bankers: Citi's forecast of what happens to the global central bank "impulse", or annual change, over the next two years and - as Lorenzen shows - its correlation to inflation expectations via real 5Y5Y forwards. The chart cleary shows the recent contraction in global central bank assets (including Chinese FX reserves) which took place as deflation fears swept the globe and as global stocks tumbled in late 2015 and early 2016. More importantly, the chart projects when the next such contraction is expected to take place...
The chart also shows that when it comes to the S&P, the Fed's balance sheet is all that mattered for years until recently both the BOJ and ECB picked up the torch and spread the "liquidity load" making the recent all time highs in the market possible, even as the Fed's balance sheet has been flat and the Fed has been cautiously tightening.
As Citi puts its best: "the principal transmission channel to the real economy has been... lifting asset prices." That however has required continuous CB balance sheet growth, and with the Fed, ECB and BOJ all poised to "renormalize" over the next year, the global monetary impulse is set to turn negative in the coming year.
Meanwhile, as financial markets scramble to maximize every last ounce of what central bank impulse remains, we get such bubbles as London real estate, bitcoin and vintage cars, or as Citi puts it: "the wealth effect is stretching farther and farther afield."
One final chart: how does it all end, and what is the "key risk" to financial stability? Here, unlike the ECB, Citi's opinion is just a little different, and echose what we have said since the beginning:
"Monetary policy has left the allocation into risky assets stretched at very high prices in a modest recovery with major structural issues still unresolved. The efficacy of existing policy tools in the future seems greatly diminished."
Citi's conclusion: the "Achilles heel is the potential unravelling of distortions built up by monetary policy itself." It hardly needs an explanation.