A noted trading author, Mark Douglas, once wrote “every moment in the market is unique” – you can definitely say that again! And perhaps there has never been a market dynamic as unique as the current one.
We have US equity markets near all-time highs while roughly 80% of global equity markets are in confirmed downtrends. Moreover, the massive unwind in the commodities space and emerging markets sends a powerful signal of rapidly slowing growth. The European recession that has no clear end in sight also adds to the global deflationary pressures – not to put too fine a point on it, but the recent gold crash screams DEFLATION and the market suddenly appears unconvinced that global central banks can do much to combat the various powerful deflationary forces currently at work.
The Fed has expanded its balance sheet to over $3.2 trillion and continues to do so at a rate of $85 billion/month. Today, St. Louis Fed President Bullard opened the door to the possibility that the Fed can do MORE. Say what? Bullard said that if inflation falls to uncomfortably low levels (he probably means below 1% on core-CPI) the Fed could increase the pace of its asset purchases. Given that we have seen a significant commodity meltdown in recent weeks, 1% on core-CPI may not be far off.
Meanwhile, the Bank of Japan has strongly stated that it is targeting 2% inflation within two years and that it will stop at nothing in order to achieve its goal. The ECB which has been fairly tight with its policy easing actions in recent months is likely to also snap into action shortly as several core eurozone economies (Italy, Spain, France, etc.) sink deeper into recession.
All of this begs many questions: What is the endgame? When does all of the extraordinary central bank actions become too much and trigger undesirable side-effects? Does QE create isolated asset price bubbles (high-yield debt, equities, etc.) while having limited positive effects on the underlying economy? Is QE effective in combating disinflationary pressures? Is there any possibility of monetary policy ever normalizing?
“Monetary easing might be helpful but the role is very much limited…….It is a necessary but not sufficient condition.” – Jin Liqun, Chairman of China Investment Corp (China’s sovereign wealth fund)
“Monetary policy cannot effectively address labor market inefficiencies, because improvements on one dimension are simultaneously detriments on other dimensions” – Ravenna & Walsh paper cited in Bullard’s speech this morning
I don’t have all the answers to these questions but I think we can deduce some insights from what we know to date:
- QE has been effective in stimulating the animal spirits of financial markets at various times during the last 5 years, but the positive effects have usually proven to be transitory as the “patient” has consistently required additional and larger doses of “medicine” once central banks tried to pull back on the QE spigot
- While central bank actions helped to break the vicious deflationary downward spiral in early 2009, the global disinflationary pressures have remained persistent and diverse in terms of their sources
- There is no clear endgame for central bank balance sheet expansion with most economists proclaiming that “policy normalization” will take a decade or longer
- Higher inflation levels require economy wide credit expansion – this has been slow to take hold as most US consumers are already heavily burdened by debt and the gap between the “haves” and “have nots” has only grown wider since the financial crisis
- As confirmed by former Federal Reserve Chairman Paul Volcker, central banks have NEVER been able to effectively target inflation levels, what makes anyone think this time will be different?….
I expect global central banks to continue doing the only thing they know how to do: Continue policy easing and blow bigger bubbles until their hands are forced into slowly turning off the spigots. However, there is no precedent for a situation in which the largest global central banks continue to aggressively ease while emerging economies are dealing with rapidly slowing growth and uncomfortably high levels of inflation. Something has to give, and I believe we are beginning to see this quite clearly in emerging markets and commodities. We live in interesting times and this moment in the market is especially unique.
If you believe that global central banks have it all figured out and will be able to successfully navigate the global economy to safe ports with little or no unintended consequences then perhaps the recent gold crash is justified. However, if you believe otherwise (like I do) then the market may have just offered you an exceptional investment entry point.