Central Bank Confidence Game
Draghi signaled a fresh round of monetary stimulus last week, and risk assets staged a spirited rally from deep sell offs that had occurred this month. High profile warnings from Soros, Gundlach, Dalio, William White of the OECD, etc, had instilled peak pessimism in global markets, with the SPX trading well below August’s lows and the VIX rallying above 30 on Wednesday. On Thursday morning the market heard echoes of “whatever it takes” from Draghi, and it was enough to spur short covering. The question now becomes, “how far will it carry?” and, “has the fundamental backdrop that sparked this month’s rout really changed?” The latter question is clearly the key, and puts the spotlight right back on the Fed and Wednesday’s FOMC announcement. If the Fed backs up Draghi by putting the market on notice that its tightening campaign may be suspended, then said market will have to reconsider its bearishness.
Crude oil rallied about 15% from Wednesday’s low. It sounds huge, except for the fact that in the beginning of November CLH6 was above 50, and had fallen below 28 by early Wednesday. In that light, a bounce to a bit over 32 doesn’t seem quite as impressive. Nor does the stock rally. However, interest rate markets had to make a concession in sympathy with the global matrix, and the treasury curve tacked on a few basis points of yield. On the week, the ten year treasury rose all of 2 bps to 2.05%; hardly an “all clear” endorsement for risky assets. Implied vol recoiled from elevated levels as well, a part of the same dynamic. VIX fell back to 22.3.
Central bankers are necessarily concerned with the global financial architecture as the core transmission mechanism for monetary policy. That’s why there are stress tests and somber faced officials supporting implementation of macroprudential rules in order to foster confidence in the system. [Exhibit A]
Now I’m no expert in international banking, but I do know a suspicious stock chart when I see one. I present Exhibit A above, which shows Deutsche Bank, Credit Suisse and JPM since 2006. DB and CS are at 2009 crisis lows! US financial institutions have generally fared much better, but it’s all interconnected. Clearly, a couple of stocks aren’t necessarily instructive with respect to the health of the global financial system. And I haven’t checked CDS and other risk measures of the banking universe. However, what springs to mind is a Far Side cartoon:
I don’t know how to insert a picture of the European Banking System. But it’s in the ‘Don’t Touch’ category, just as sure as a guy wearing a shoe for a hat.
Which brings us to the crux of the problem. According to Felix Zulauf, global equities have lost $16.4 TRILLION of market cap since the middle of 2015, from 73.2 to 56.8. That’s a staggering statistic. Can we trust the central bankers to reverse market messages (and rebuild asset values)? The fact that the market routinely ignores the Fed dots gives an indication. And there are other clues. From Mauldin: “Something else China Beige Book noticed last quarter: both business and consumer loan volume did not grow in response to lower interest rates. That’s an important change, and probably not a good one. It means monetary stimulus from Beijing can’t save the day this time. Leland thinks fiscal stimulus isn’t likely to help, either. Like other governments and their central banks, China is running out of economic ammunition.” At Davos, the BoJ’s Kuroda suggested the Chinese institute capital controls rather than burning through reserves. I am sure the Chinese are thinking Kuroda has enough on his own plate, given the loss of effectiveness of QE in Japan.
I know it’s a tired theme, but the question is, have global central banks lost credibility? Can they ‘save the day’? I think we are on the cusp of a definitive answer, and I think the political climate both in the US and across the world is indicative of a loss of confidence in long standing institutions, including Central Banks.
