Pushing Desperate Measures Too Far
Another unsettled week for global markets. Japan’s Nikkei equities index rallied 6.5%. Italian bank stocks surged 10%, with the Europe STOXX 600 Bank Index up 8.1%. Germany’s DAX equities index rallied 4.5%, with Spanish stocks up 5.0% and Italian 4.3%. Hong Kong’s Hang Seng Financials index surged 5.9%. The EM market rally continued. U.S. bank stocks jumped 7.0%. A Friday evening Bloomberg headline: “Rough Week for Shorts as Banks Send S&P 500 to Four-Month High.”
Recalling back to 2008, U.S. financial stocks surged 10% in a single session. Reminiscent of 2008 market dynamics, global bonds aren’t much buying into the equities market “risk on.” Japanese 10-year (JGB) yields fell three bps (to negative 13bps), and German yields increased only four bps (to 13bps). Ten-year Treasury yields rose four bps, taking back only two-thirds of last week’s decline. European periphery spreads tightened only marginally.
Policy-induced short squeezes do tend to take on lives of their own. This one’s no exception. The basic premise is that years of central bank monetary inflation and market manipulation have nurtured a “global pool of speculative finance” of incredible dimensions. The unstable dynamic of “too much ‘money’ chasing too few real opportunities” – along with the associated “Crowded Trade” phenomenon – has made it extraordinarily difficult for active managers to compete with the indices. And as “money” continues to gravitate to passive bets on the major indices, the markets’ dysfunctional trend-following/performance-chasing dynamic becomes only more deeply entrenched (and detached from fundamentals). When markets lurch higher, irrepressible forces begin pulling everyone in.
Recall back to the tumultuous January and early February period. Global “Risk Off” was in control. Crude traded down to about $27 a barrel. Global equities were under intense pressure, led lower by commodity producers and financial stocks. EM currencies were under liquidation. Chinese stocks were in free-fall, trading at about half the level of summer highs. The Chinese currency was under pressure, with unprecedented quantities of “money” fleeing the bursting Chinese Bubble.
The prevailing bullish view from December was that the U.S. economy was on solid footing, allowing the Fed to finally move forward with rate normalization. The European recovery had gained self-sustaining momentum. In Japan, yen devaluation had successfully boosted corporate profits and stock prices, positioning the economy for decent growth. The world was looking at China through rose-colored glasses, believing Chinese officials were adeptly orchestrating the mythological “soft-landing.” At the same time, a compelling argument could be made that an ongoing Chinese boom was all that was holding a global deflationary spiral at bay. A Chinese hard landing would dictate major revisions to large numbers of market and growth assumptions around the globe.
Keep in mind that Chinese system Credit (“total social financing”) surged 12.4% in 2015, or almost $2.4 TN – a massive amount of Credit still insufficient to levitate global energy and commodity prices. The hard landing scenario – appearing increasingly probable back in January and February – would potentially see a significant slowing, or even halt, to the Chinese Credit boom.
It’s worth recalling that total U.S. mortgage Credit expanded $1.4 TN in 2006, dropped to $95 billion in 2008 and then contracted $290 billion in 2009. After expanding 10.9% in 1988, U.S. corporate Credit contracted 2.1% in 1991. U.S. corporate Credit expanded about double-digits in both 1998 and 1999, with growth slowing to 3.2% in 2001 and then flat-lining in 2002 and 2003. More dramatically, 2007 saw 11.5% U.S. corporate Credit growth, which turned to a 5.2% contraction in 2009. Have Chinese officials actually convinced themselves that they’ve repealed the Credit Cycle?
Examining further back in U.S. Bubble history, the nineties began with 1990’s $688 billion U.S. Non-Financial Debt (NFD). Credit issues (burst late-80s Bubble) and recession saw NFD growth slow to $527 billion (2/3 govt. borrowings) in 1991. The nineties Credit boom gained momentum throughout the decade, with over $1.0 TN of NFD growth in boom-years 1998 and 1999 (NFD growth averaged $770 billion annually throughout the nineties). NFD growth slowed to $884 billion in 2000, before resuming its rapid ascent. NFD growth was up to $1.695 TN by 2003, then surpassed $2.0 TN annually in Bubble years 2004 through 2007. Credit crisis saw NFD growth collapse to $829 billion in 2009, with an outright contraction of private-sector debt offset by massive Treasury borrowings.
U.S. data help put the spectacular Chinese Credit boom into clearer perspective. And when it comes to Credit Bubbles, there can be a fine line between burst and boom climax. Rather than the bust that appeared likely in 2016’s initial weeks, the first quarter witnessed record Chinese Credit expansion. Friday data showed Chinese March total social financing jumping $360 billion (led by a surge in bank lending). This was somewhat less than January’s incredible $520 billion expansion, though it did push Q1 Credit growth above $1.0 TN (historic).
Not long ago Chinese officials had set their sights on reining in rampant Credit growth. Having clearly reversed course, Credit expanded during the quarter at a blistering almost 20%. This compares to its recent official target of 13% and China’s GDP target of 6.5-7.0%. In such a circumstance, what is the prognosis for Chinese currency stability? Uncharted Territory.
With markets in a tailspin and “money” fleeing China, reasonable analysis back in January might have anticipated Chinese 2016 Credit slowing to, say, $1.5 TN. It will instead likely double this amount. When one is pondering the unstable 2016’s market backdrop, it’s helpful to think in terms of China as the marginal source of global Credit. The immediate good news for equities and commodities is that Chinese central planning still holds astounding sway over the nation’s lending and investing. The ongoing good news for global bonds is that this historic experiment in state-directed Credit and economic management is in peril. The extremely bad news for China – as well as global markets and economy – is that $3.0 TN of unsound Credit at this very late stage of the Credit cycle ensures an even more destabilizing bust.
It must be tempting for the believers to again revel in the brute power of the “perpetual money machine.” Yet the costs associated with the latest round of monetary inflation are steep. Not many months ago it appeared that China was determined to rein in excess, while the U.S. was ready to lead the world toward policy normalization. Today it’s become rather obvious that China is out of control and global policymakers are trapped at near zero or negative rates and perpetual QE monetary inflation. What was always sold as temporary extraordinary measures is increasingly recognized as desperate “whatever it takes” indefinitely.
To reverse a rapidly strengthening de-risking/de-leveraging dynamic central bankers were compelled to convey to the markets that they were still very much in control with virtually limitless ammunition. Rates could go deeply negative. QE would expand as big as necessary. And, for emphasis, if required central banks still had “helicopter money” – printing ‘money’ and disseminating it directly to consumers – waiting in the wings. They pushed Desperate Measures Too Far this time.
April 12 – Reuters (Gernot Heller and Paul Carrel): “The European Central Bank’s record low interest rates are causing ‘extraordinary problems’ for German banks and pensioners and risk undermining voters’ support for European integration, Finance Minister Wolfgang Schaeuble told Reuters… Politicians from Chancellor Angela Merkel conservative camp, to which the finance minister belongs, have complained the ECB’s ultra-low rates are creating a ‘gaping hole’ in savers’ finances and pensioners’ retirement plans as returns have dropped. Schaeuble suggested they risked fuelling the rise of euroscepticism in Germany, where voters flocked to the right-wing Alternative for Germany in state elections last month. ‘It is undisputable that the policy of low interest rates is causing extraordinary problems for the banks and the whole financial sector in Germany… That also applies for retirement provisions.’ ‘That is why I always point out that this does not necessarily strengthen citizens’ readiness to trust in European integration,’ he added… A storm of protest erupted in thrifty Germany after ECB President Mario Draghi last month described the idea of so-called helicopter money – sending money directly to citizens – as a ‘very interesting’, if unexamined, concept.”
April 10 – Reuters (Michelle Martin): “A chorus of conservative German politicians have criticised the European Central Bank for its interest rate policy, which they say is hitting the retirement provisions of ordinary Germans, could lead to asset bubbles and even boost the right-wing. German Finance Minister Wolfgang Schaeuble partly blamed the ECB’s policy for the success of the right-wing Alternative for Germany (AfD) in recent regional elections, which saw it take up to a quarter of votes in a setback to Schaeuble’s conservatives… The newspaper quoted Schaeuble as saying he had told ECB President Mario Draghi: ‘Be very proud: You can attribute 50% of the results of a party that seems to be new and successful in Germany to the design of this [monetary] policy.’”
April 14 – CNBC (Matthew J. Belvedere): “BlackRock chief Larry Fink said… that negative and low interest rates around the world are crushing savers, and those policies are ‘going to become the biggest crisis globally.’ …Fink called on political leaders to step in and provide fiscal reform to complement monetary policy. ‘We have become too dependent on central bankers’ to boost the global economies, he said, stressing easy money policies were supposed to be a temporary healing. ‘I don’t call seven, eight years temporary… I don’t see how that [still] has a positive impact.’ ‘Over 70% of our clients are retirement plans and insurance plans. Our clients are in pain… Our clients are very worried how they’re going to be meet their liabilities’ because the yields are so low in the bond market.’”
April 14 – Bloomberg (Finbarr Flynn and Gareth Allan): “The top executive of Japan’s biggest bank delivered a rare criticism of the central bank, saying its negative interest-rate policy has contributed to anxiety among households and companies and prolonging it may weaken financial institutions. ‘Both households and businesses have become skeptical about the effectiveness of policy measures to address the current economic problems,’ Nobuyuki Hirano, president of Mitsubishi UFJ Financial Group Inc., said… Hirano said there’s ‘no guarantee’ that negative rates will encourage companies to increase capital spending because low borrowing costs and deflation have been ‘business as usual for over a decade.’”
Albeit the Germans, Japanese bankers, pension fund managers or even the general public, it’s been a frustratingly long wait for policy normalization. And just when hope was running high, the rug was pulled right out from under. Around the world many had patiently accepted the favoritism and inequity of reflationary measures. But what was supposed to be extraordinary and temporary morphed into the normal and permanent: egregious wealth redistribution.
The course of global monetary policy increasingly lacks credibility. Patience has worn thin. Frustration and anger are being brought to the boil. Sure, global markets have gained momentum. But I actually think “whatever it takes” central banking has about run its course, with momentous ramifications for global market Bubbles. Reminiscent of how I felt in 2008, global markets would be a lot better off had they taken their medicine earlier.
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