Global Macro Commentary
Tangled Up in Blue
by Guy Haselmann, Director, Capital Markets Strategy, Scotiabank GBM
FED
· Last Friday, I attended the University of Chicago’s annual US Monetary Policy Forum. Several (imprecise) headlines hit the tapes that day from statements made by FOMC members in attendance. After a few presentations and personal conversations with FOMC members, I became even more convinced that the word ‘patient’ will be removed at next week’s meeting and that the first hike (since 2006) will occur in June.
· Stan Fischer stole the show with an outstanding presentation and concise answers to pointed questions. One of his main messages was that forward guidance would soon be going away. He questioned the rationale of constraining the Fed’s flexibility through some type of calendar-based future promise. He further added that after ‘lift-off’ there was no reason to telegraph each meeting; but, no need to surprise markets either. He said that the Fed “will maintain its credibility by doing the things that we say we will do” (e.g., a June lift-off?).
· It is hard to imagine after listening to Fischer that ‘patient’ will remain in the March statement. Even those who expect ‘lift-off’ to be delayed until 2016 would probably come to the same conclusion, because to them, removing ‘patient’ still does not ensure or guarantee a June hike.
· There are those who believe the Fed will not hike rates at all in 2015, because inflation is too low and falling. Yet, during Fischer’s discussion about future policy, he said that in order for the Fed to think about ‘lift-off’, the FOMC needs to be confident that inflation will move towards its 2% target “in 2 to 3 years”. He then added that the Fed is confident that it will, so “now is the time for the Fed to be thinking about ‘lift-off’”.
· The intent of the first panel of the day was to discuss this year’s academic paper about “The Equilibrium Real Fed Funds Rate”. The conclusion of the paper, without getting into the details, suggested that Fed rate hikes in this cycle should be ‘later and steeper’. Dudley and Mester were on the panel. Rather than just agreeing with the conclusions of the paper - to justify the path of their policy stance - it was surprising that Mester actually argued that “later” has already arrived. In other words, she agreed that when you hit the ZLB (zero lower bound) that “you have to make up for it on the other side by delaying the first hike”. She said that the Fed has “done this already”.
· Mester emphasized that Fed “models cannot measure costs of financial instability, and such argues for an earlier hike”. She added that “continuing to delay hikes has serious implications for financial stability, and at some point ‘uncertainty aversion’ carries more weight”. In this regard, she stated that the Fed Funds rate should have been lifted already.
ECB
· Many details of the ECB’s QE program were announced today; a list of particulars that is too long and complex to list here. Yet, all may not be what it seems. While markets are trying to price-in and prepare for the €60 billion per month program until at least September 2016, I believe there is a reasonable chance that the program ends well in advance of this date.
· Once again, Draghi was masterful. His press conference delivered a reasonably upbeat message about the considerable progress that is already being observed. He specifically cited and emphasized such factors as oil, the weaker Euro currency, and prior monetary policy actions. In fact, he was so upbeat at times that a casual observer might have wondered why this program was necessary to begin with. He even confessed that the drop in inflation was largely due to weaker energy prices; something expected to reverse in early in 2016.
· Draghi called this the “final plan”. Maybe he felt that one more shot of adrenaline was necessary to help sustain his progress, and to buy time while the necessary structural reform details (that he outlined) can be hashed out. In order to prevent markets from testing his resolve, the ECB unleashed what has appeared to be a ‘shock and awe’ program. Flaunting the arsenal can be effective, but it is possible that it will not be used in its entirety, as announced. The ECB might make early progress on its target, or run into operational problems due to unwilling sellers, or due to bond yields that have gotten too negative.
· ECB QE will cause an even greater shortage of high-quality government bonds. Moreover, those who sell bonds to the ECB will have reinvestment risk; something that does not receive enough attention. It will further increase pressure on investors to take extra risk. As asset prices continue to rise, the global financial system is becoming ever-more fragile. More investors are climbing outside of their usual comfort zone, taking higher risks than they are used to.
· On a final point, risks to financial assets can no longer be assessed, because the mechanisms to discount cash flows are broken. If the “risk free” rate locks an investor into a guaranteed loss (or zero return), then how can it be “risk-free”. When this rate is distorted, any attempt to price any asset will be miscalculated and incorrectly priced.
· As central Banks have raced each other to the bottom, little is left to power risk-assets forward (into more extreme mispricings). The last marginal speculator is already in. At this point, newly acquired cash and lower yields are likely only to spur greater levels of savings and hoarding of cash. The ‘Minsky Moment’ has finally arrived.
“All warfare is based on deception.” – Sun Tzu
Regards,
Guy
Guy Haselmann | Director, Capital Markets Strategy
▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬▬
Scotiabank | Global Banking and Markets
250 Vesey Street | New York, NY 10281
T-212.225.6686 | C-917-325-5816
guy.haselmann[at]scotiabank.com
Scotiabank is a business name used by The Bank of Nova Scotia
Read/Download the complete report below:
