Back in June, Citi's credit strategist Hans Lorenzen pointed out that while QE had failed to spark inflation across the broader economy, it had achieved something else: "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."
Three months later, the latest to tackle the issue of central bank bubble creation, is BofA's Barnaby Martin, who in a note released overnight asks rhetorically "are bubbles becoming more “bubbly”?
Just like Lorenzen, Martin observes the blanket central bank “lower for longer” rates intervention, which leads to "speculative behavior in assets." Well, technically, Martin hedges by calling it a "risk", but one look at the chart above and below shows that the bubbles created by central banks are all too real. And as Martin, whose topic is the unprecedented buying spree across credit, notes it’s not just credit markets that are seeing exceptional investor demand at this point in the cycle: so is everything else, or as he puts it:
"As chart 3, over the page shows, asset bubbles seem to be becoming more “bubbly” as time goes by."
What he means by this is that post the financial-crisis, "the largesse of central banks appears to be inducing quicker and steeper price gains in assets compared to the case historically."
For instance, the increase in Japanese equities was pronounced between mid-1982 and the end of 1989, with share prices rising around 440% over the period. But Bitcoin, for instance, has risen roughly 2000% since just mid-2015. And other, recent, in-vogue indices seem to be surging higher as well.
Not surprisingly, just like Lorzenen three months ago, Martin agrees that there is are two key events which would immediately put an end to these "bubbly" bubbles: an inflationary shock, or the ECB putting a hard stop to its bond monetizing largesse .
In our view, an end to the bullish credit cycle in Europe can only come about once the major inflows dry up. For us, this will require more than just the ECB tapering their bond purchases next year. Witness, for example, the strength of Sterling credit spreads over the last few months despite the BoE’s corporate bond buying programme “hard stopping” in April this year.
More than just central bank jawboning, however, Martin thinks "the end of the credit party will likely require a big inflationary “shock” in Europe, and one strong enough to reset market expectations over the pace of rate hikes. Safe to say that this seems a long way off to us."
As a result, helped by falling political uncertainty (note European policy uncertainty is now lower than US policy uncertainty – the first time since mid-2012) and the renewed rise in negative yielding assets (note record number of European countries now with negative yielding debt), we see credit spreads heading tighter into year-end.
And yes, this means after the latest correction, Bitcoin will keep going higher...