Here Comes the Dark Money
We all know the adage: The more things change, the more they stay the same. It’s especially like that with central banks.
Central bank representatives from 40 different nations recently made their way to the Kansas City Fed’s Jackson Hole Economic Policy Symposium.
The conference itself began in 1978, six years after the end of the gold standard. In 1982, it moved permanently to Jackson Hole, Wyoming, where it became a sort of summer camp for international central bankers. The late-August festivities take place at the Jackson Lake Lodge, which is a U.S. National Park Service facility, giving it that rustic, yet elitist, sort of feel.
Each year the symposium has a unique theme. This year, that theme was “Challenges for Monetary Policy” (original, right?)
According to pre-symposium material, the topic was chosen because “monetary policymakers face a range of challenges as they pursue their mandates” since the financial crisis.
The powers of Capt. Obvious go on to elaborate: “Different rates of recovery have led central banks to chart different courses for the normalization of monetary policy following a period in which most central banks used both conventional and unconventional monetary policy tools” to handle the Great Recession.
Another main topic of the conference was how to unwind these unconventional policy actions. But here’s the thing: That’s only if unwinding is even on the menu right now. And therein lies the real difference. It’s the growing gap between what the Fed leader wants to say about unwinding versus what he and other central banks are actually doing.
The U.S. stock market has gained more than 300% from its financial crisis low of 666 in March 2009. Other major economy stock markets have followed suit, albeit not with quite as much fervor, and, more recently, with growing volatility in the mix.
The second outcome of the central banking jubilee was a debt boom. The world’s debt pile sat at a record $244 trillion as of the beginning of this year. That’s more than three times the size of global GDP. The amount of debt is particularly high in the emerging-market countries, where it has taken the form of government debt and corporate debt denominated in U.S. dollars.
The U.S. dollar strengthened first on the back of the Fed’s tightening policies from late 2015 through late 2018. Then as other economies slowed down relative to the U.S. and their central banks cut rates to ostensibly stimulate growth, the cost of servicing this debt has increased.
If economies outside the U.S. weaken further, payment and internal domestic budgeting will get even more precarious. This will produce more geopolitical tension, more nationalism and trade wars, and more business and financial uncertainty.
As a result, there will continue to be more overall central bank maneuvering toward looser monetary policy. But this time, more central banks will join in. Let’s consider the list of central banks loosening policy.
The Bank of Canada: For the first time in almost three years, the Bank of Canada lowered its five-year benchmark rate. The Bank dropped the rate 15 basis points, from 5.34% to 5.19%, primarily because Canada’s big banks have decreased their five-year posted rates.
Canada’s central bank gave almost no indication that it was nearing a rate cut, but it had signaled major concerns about the trade climate — especially between the U.S. and China.
European Central Bank: At the end of October, current ECB leader Mario Draghi will be handing over his money-conjuring baton to now-former IMF leader Christine Lagarde, as mentioned above. He is aware that ultra-loose monetary policy — like the ECB’s deposit rate of -0.4%, which still has the power to startle — has done little to spark inflation in the eurozone.
In order for her to be able to keep true to his ultra-dovish legacy, Draghi has given Lagarde all the headroom she needs to keep monetary policy as loose as she possibly can, even if inflation exceeds the 2% target, which it probably won’t.
Last month, the ECB left its key interest rate at -0.4% but sent strong signals that it might cut even deeper into negative territory as soon as September 12. It also hinted that it could restart the huge asset-buying program it ended in December to boost the eurozone economy.
The ECB is the latest G7 central bank to hint that lower rates are imminent in an effort to stave off a global slowdown and trade war risk and to ramp up below-target inflation.
In the meantime, Draghi looks like he may end his term in October the way he started: with quantitative easing (let’s hear it for Super Mario!).
Those are just two examples. But both before and after the Fed cut U.S. interest rates on July 31, many central banks from emerging markets around the globe did the same, with an increasing number of them not even waiting for the Fed’s move.
Central banks from the world’s largest emerging-market countries have thus sent a clear signal that even with global debt at new highs, especially in EM countries, policymakers are invoking easy money and more market stimulus.
On the surface, the Fed’s rate cut in July was expected to weaken the dollar, something that President Trump and U.S. businesses have demanded since 2018. However, as central banks around the globe turn dovish, the dollar could actually continue its outperformance, by default.
That’s why the Fed has less ability to tweak the dollar than President Trump would like. The Fed doesn’t exist in isolation, but in a world of other central banks that react to it.
That’s especially important to keep in mind since uncertainty about Brexit and possible U.K. elections, the U.S.-China trade war, the slowing eurozone and EM economic and periodically acute turmoil, like Argentina’s markets falling by nearly 50% in a day, weigh on sentiment.
In turn, this turmoil boosts the dollar’s safe-haven appeal, and by extension U.S. financial asset markets.
When the Fed cut rates in July, it unleashed easy policy thinking amongst central banks that had thought, as recently as late 2018, they were supposed to embark upon a tightening platform to keep up. Now they have had to do a 180 to keep their economies and markets fueled by cheaper money as the bigger countries embark upon a renewed dovish period.
Into this vortex, Fed Chair Jerome Powell delivered his keynote speech at Jackson Hole on Aug. 23. What he said is the worst of all worlds for central banks and markets. He was wishy-washy about the Fed’s direction. So the Fed’s actions will remain a puzzle. However, other major central banks will ease because they can.
But here’s the bottom line: a flood of dark money from around the world is on the way. It won’t do much to help the global economy, if the past 10 years are any indication. But it’ll probably give the markets another (artificial) jolt.
In other words, it’ll just kick the can down the road until the ultimate day of reckoning.
for The Daily Reckoning