January 23, 2015 11:01 am
Markets’ misplaced faith in central banks
Tracy Alloway
ECB revives cult with €60bn a month of bond buying
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Our Draghi, who art in Frankfurt, hallowed be thy name.
The influence of central banks has been felt across almost every asset class and the belief in the ability of monetary policy to heal all financial wounds has turned traditional market relationships on their heads.
In Switzerland, Japan and the eurozone there is now a whopping $7.3tn worth of negative-yielding government debt. The same BofAML analysts estimate about 83 per cent of the free-float stock market to be supported through low interest rates.
It is not that traders and investors necessarily took a view one way or the other on the efficacy of the central bankers’ commandments in healing the wider economy or improving the return profile of these assets.
Rather that the belief in the potential for central bank support gave succour to those who needed the comfort of a friendly, caring, all-knowing higher monetary policy power.
As Ben Hunt, chief risk officer at asset manager Salient Partners, puts it: “We pray for extraordinary monetary policy accommodation as a sign of our central bankers’ love, not because we think the policy will do much of anything to solve our real-world economic problems, but because their favour gives us confidence to stay in the market.” Sometimes ‘cult’ is too soft a word.
For investors who had taken the SNB’s maxim that it would defend the cap with the “utmost determination” as gospel, this was a shock to the system.
For apostates, the SNB’s move was proof that central banks were far from the infallible beings markets have believed them to be for so long.
Whatever one’s monetary policy ideology, the results of the SNB move proved truly painful, with large banks, hedge funds and brokers taking hefty losses on the move — evidence again that the belief in the central banks’ dominion has come to saturate large swaths of the market.
Risk management models have been calibrated by years of low volatility and near zero rates, while many investors had come to rely on a stable Swiss franc to finance myriad other trades.
No doubt his benevolence this week will encourage the believers to pile into European stocks and bonds in the short term, but how many more economic miracles can the central banking cult call upon? Sooner or later, the market’s belief system will be tested again.
Crises of faith are rarely pleasant experiences and the unwinding of the central bank cult — when it comes — looks set to be no different.
Mario Draghi’s €1.1tn of shock and awe — €60bn a month of bond buying until September 2016 — might yet turn out to be insufficient to kickstart a moribund eurozone, but it is possible that it has achieved something more important for the animal spirits of markets: a revival in the cult of central banks.
For the last six years many on Wall Street have knelt at the altar of central banks, singing the praises of bulk asset purchases and taking for granted the omnipotence of the men and women who run them.
The influence of central banks has been felt across almost every asset class and the belief in the ability of monetary policy to heal all financial wounds has turned traditional market relationships on their heads.
To wit, those who have begun working in the financial industry in the past four-and-a-half years likely lack any first-hand experience of a period without ultra-low interest rates and the corresponding suppressed volatility levels.
Many are likely to be unfamiliar with a time when corporate default rates were anything more than low single-digits. Nor are they likely to remember, say, the days when investors bought government bonds for income; Bank of America Merrill Lynch analysts reckon that 52 per cent of all government bonds now yield less than 1 per cent.
It is not that traders and investors necessarily took a view one way or the other on the efficacy of the central bankers’ commandments in healing the wider economy or improving the return profile of these assets.
Rather that the belief in the potential for central bank support gave succour to those who needed the comfort of a friendly, caring, all-knowing higher monetary policy power.
As Ben Hunt, chief risk officer at asset manager Salient Partners, puts it: “We pray for extraordinary monetary policy accommodation as a sign of our central bankers’ love, not because we think the policy will do much of anything to solve our real-world economic problems, but because their favour gives us confidence to stay in the market.” Sometimes ‘cult’ is too soft a word.
And yet the market’s faith had been shaken when, last week, the Swiss National Bank abandoned its currency peg, removing in one fell swoop what Jean-Pierre Danthine, SNB vice-president, had labelled a “pillar” of monetary policy only three days before.
For apostates, the SNB’s move was proof that central banks were far from the infallible beings markets have believed them to be for so long.
As Marc Ostwald at Monument Securities put it at the time: “This is symptomatic of the whole mirage of stability that the developed world central banks have sought to foster in the post-crisis era starting to unravel in a rather disorderly fashion.”
Whatever one’s monetary policy ideology, the results of the SNB move proved truly painful, with large banks, hedge funds and brokers taking hefty losses on the move — evidence again that the belief in the central banks’ dominion has come to saturate large swaths of the market.
Risk management models have been calibrated by years of low volatility and near zero rates, while many investors had come to rely on a stable Swiss franc to finance myriad other trades.
But it seems that Super Mario has now stepped in to calm those whose adherence to the cult had begun to waiver.
Crises of faith are rarely pleasant experiences and the unwinding of the central bank cult — when it comes — looks set to be no different.
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