Risk Off, the BOJ and China
Is a meaningful de-risking/de-leveraging episode possible with global central banks injecting liquidity at the current almost $2.0 TN annualized pace?
Thus far, central bankers have successfully quashed every incipient Risk Off. Market tumult has repeatedly been reversed by central bank assurances of even more aggressive monetary stimulus. The flood gates were opened with 2012’s global concerted “whatever it takes.” Massive QE did not, however, prevent 2013’s “taper tantrum.” Previously unimaginable ECB and BOJ QE coupled with ultra-loose monetary policy from the Fed were barely enough to keep global markets from seizing up earlier in the year.
It’s my long-held view that market interventions and liquidity backstops work primarily to promote speculative excess and resulting Bubbles. While celebrated as “enlightened policymaking” throughout the markets, an “activist” governmental role (fiscal, central bank, GSE, etc.) is inevitably destabilizing. The upshot of now two decades of activism is a global marketplace dominated by speculation and leveraging.
I’ll posit that a given size of “liquidity backstop” fosters a commensurate speculative response in the marketplace, ensuring that a larger future backstop/intervention will be required come the next serious de-risking/de-leveraging episode. The essence of the current (global government finance) Bubble is that central banks have committed to doing “whatever it takes” – and this moving target “whatever it will take” has kept inflating right along with speculative market and asset Bubbles across the globe. This scheme has gone on for years. A Day of Reckoning cannot be postponed indefinitely.
This is clearly a more pressing issue for me than for other analysts. Speculative Bubbles tend to climax with a terminal furry of exuberance, excess and dislocation. A final destabilizing tsunami of financial flows and attendant price spikes ensure that grossly inflated market confidence and price levels turn untenable. Then comes the painful Reversal.
Global sovereign debt and bond markets this year were overwhelmed by “blow-off” excess. The biggest cash markets in the world along with the biggest derivative markets in the world dislocated in historic “melt-up.” Effects became systemic. Price impacts were extreme – historic. Virtually all asset classes were significantly disrupted by Bubble Dynamics. To be sure, there was newfound exuberance in the power and sustainability of “whatever it takes.”
From my analytical perspective, it appears we’re again nearing another “critical juncture,” yet another potential major inflection point. And the probability that such prognostication ends up looking foolhardy is not small. After all, central bankers have repeatedly had their way – imposed their will upon the markets. On the other hand, if we have indeed reached a critical point for acutely vulnerable markets, few are prepared. Of course, almost everyone is convinced they have the answer to the opening question: “No, and this was proved earlier in the year.”
Let’s take a different tack. Would $167bn ($2TN/12), a month of global QE, be sufficient to hold Risk Off at bay? How about $38 billion during a week of intense market tumult? The proverbial drop in the bucket. I actually believe that the global Bubble has inflated to such precarious extremes that even $2.0 TN of central bank purchases would in rather short order be overwhelmed in the event of a major bout of speculative de-leveraging. Let me suggest that the almighty central banker liquidity backstop arsenal would wither in the face of a synchronized global liquidation across various asset classes. What’s more, the possibility of just such an outcome has greatly increased after the recent global bout of synchronized central bank-induced speculative excess.
By the look of markets over the past week or two, the six-month central bank-induced respite appears to be winding down. The ghosts of January and February have reawakened: Europe, global banks, energy, EM and China (to name a few). Some Friday headlines: “Oil Falls to 1-Month Low…” “Mexican Peso Slides to Record Low…”; ‘Cost of Insuring Deutsche Bank’s debt Rises 8 percent…”; “U.S. Stock Funds Post Largest Weekly Outflows in a Year…” “Monte Paschi Bonds Slide to Two-Month Low…” “China H Shares Go From Best to Worst…”; “Low-Volatility Funds Face Rougher Ride”. “Volatility Puts Some Funds at Risk.”
Europe suffered a rough week, especially at The Fragile Periphery. In general, unimpressive rallies gave way to serious selling. Greek 10-year yields surged 33 bps to 8.45%, the high going back to April. Portugal’s 10-year spread (to bunds) widened 26 bps this week to 339 bps, the widest level since February. Italian spreads widened 10 bps to a four-month wide 134 bps. Major equities indices dropped 2.8% in Germany and 3.5% in France. Stocks were slammed 4.3% in Spain and 5.6% in Italy.
September 16 – Wall Street Journal (Jenny Strasburg): “A legal settlement half the size of the U.S. Justice Department’s $14 billion opening bid in a mortgage-securities case would exceed Deutsche Bank AG’s litigation provisions and strain its already thin capital cushion. Even a $4 billion settlement ‘would put questions around capital position,’ J.P. Morgan… analyst Kian Abouhossein said in a research note this week.”