Submitted by Michael Every of Rabobank
Welcome to NOT Wednesday NOT 9 NOT October NOT 2019, the Asian morning after the US Federal Reserve started an expansion of its balance sheet that is NOT-QE4.
It’s not really a surprise the Fed are doing this. After all, the ECB have already shifted back to doing EUR20bn of QE a month, which is supposed to do the trick after EUR80bn a month previously failed. Why? Because this time the pledge is it won’t stop, which is NOT called “monetization” because Germany has enough to worry about already. Likewise, the BOJ have never stopped doing QQE (plus YYC) and are edging closer to doing even more of it: and it’s proving just as ineffective there. China doesn’t openly do QE, of course: it just has a combined fiscal deficit of around 13% of GDP and a central bank that supports the whole pyramid scheme by repo-ing those assets as needed: and it is about to do a whole lot more too.
Plus, the Fed itself recently presided over what was NOT a humiliating and frankly scary loss of control of its key repo market, which saw overnight borrowing rates spike and necessitated adding around USD400bn of liquidity and the promise of more as needed. So why NOT just make Open Market Operations (OMO) into Permanent Open Market Operations (POMO) at a set level and ensure there are enough dollars for thems what needs as thems needs it?
Taking a step back from the alphabetti spaghetti of central-bankery we must surely see that the Econ 101 assumptions of how an economy works are NOT correct – at least NOT under our current geopolitical circumstances. Allow me to yet again repeat a simple piece of Kalecki analysis that is NOT taught in economics classes, and hence NOT used in central banks or think-tanks, and thus NOT recognised in most market research:
Banks create debt (and hence broad money-supply) via lending. If that lending goes to productive investment the stock of money and goods are matched and there is no inflation and there is no long-term increase in debt to GDP. If the productivity growth from the new enterprise is fairly split between profits (for further investment) and wages (for consumption) then the growth cycle continues without a long-term increase in debt to GDP.
However, if businesses push down wages for profit--via globalisation--then consumption growth can only be sustained by borrowing, and debt to GDP trends up: when it hits a peak, growth permanently slows. At that point, businesses have no need to borrow – or if they do it is to speculate on financial assets and not invest in productive business. Growth slows further, and the cycle breaks down structurally. Governments have to then invest more and/or force wages higher. [YOU ARE HERE].
Central banks lowering rates merely sees housing and/or equity bubbles running on fumes. Each hiking cycle is replaced by an easing where we see lower highs and lower lows until we go negative – which is de facto debt default. And/or we do QE, which the Bank for International Settlement recently agreed does not flow to the real economy, but pours more liquidity into asset markets, making the rich richer. Unless QE allows governments more room for fiscal spending - which is de facto debt default. [YOU ARE HERE]
It’s really not that hard to model the system described above – or to predict the outcomes from it. Unless you are a central bank or think-tank – because this all gets political rather than economic, and they like to pretend the two are divorced when they are NOT. Yet in an environment where central bank balance sheets MUST keep expanding--or else--how can everything NOT rapidly become political? Which is a good segue to:
Brexit, where current UK-EU talks are seen as “doomed” as neither side can resolve the Irish issue to the other’s satisfaction. The Guardian suggests a Brexit extension until June 2020 might be offered: others still worry that despite the Benn Act, Hard Brexit is NOT impossible at month end.
US-China trade talks, which start tomorrow despite the US just imposing a visa ban on Chinese officials linked to accusations of human rights abuses in Xinjiang and apparently IS pressing ahead with capital controls vis-à-vis China. We repeat our long-held view that there will be no substantive trade deal because this is NOT about trade; indeed, the US-China issue has moved from don’t-care Wall Street to do-care Main Street via the NBA – which is now banned in China after its president underlined he stands behind free speech. As one Chinese internet user notes: “US-China contact began via ping-pong, and ended with basketball.”
Turkey, where US Senator Lindsey Graham has tweeted: “To the Turkish Government: You do NOT have a green light to enter into northern Syria. There is massive bipartisan opposition in Congress, which you should see as a red line you should not cross. If you want to destroy what is left of a fragile relationship, a military invasion of Syria will do the job. #StandWithTheKurds.”
So let’s bring this back to markets. In a vacuum, the Fed’s NOT-QE4 would be USD negative and, ironically, negative for Treasury yields too given it is a net injection of liquidity vs. merely shrugging. However, in a global environment that, like Econ 101, is NOT what it used to be, it’s still better to be bullish USD--certainly over EM--and UST (though NOT-QE4 may slow the yield descent for a while). What else does one want to hold, apart from CHF and JPY perhaps, with Hard Brexit, trade/cold war, and Middle-East war all realistically on the market horizon?