While central banks’ grip on the economy seems to be waning, notes Citi’s Matt King, additional liquidity still seems as potent as ever when it comes to propping up global markets. The question in our minds revolves around whether central banks remain willing to keep pumping when the economic benefits are so questionable. Equally, though, valuations are already so elevated that we doubt they can afford to stop. One way or another, this feels like a recipe for increased volatility.
Spiralling Market; Spongy Economics
We have long argued that current market levels owe more to central bank liquidity and to the suppression of natural risk premia than they do to underlying fundamentals. Even so, we were impressed by the magnitude of the move in €//CHF following the surprise abandonment of the one-way peg by the SNB last week.
If the cessation of ‘exceptional and temporary measures’ by a central bank with assets equivalent to just 0.5% of world GDP produces such turmoil, what sort of move should we expect if central banks more broadly were to attempt a return to ‘normal’ policy?
This short note attempts to answer that question by – rather speculatively and perhaps contentiously – drawing 12 conclusions from the SNB episode. They are deliberately rather brief and assertive, in part because they draw upon a body of arguments we have made elsewhere:
1. Markets are still awash with central bank liquidity. The ‘appearance’ of a return to normality was just that. ‘Fair value’ for most assets lies far below current market levels.
2. That abundance of liquidity is pushing down global bond yields. While many of the flows into CHF seem to have been short covering, -0.75% deposit rates are clearly not providing much deterrent to inflows. This suggests that the relatively much higher yields on other safe havens, such as Bunds and Treasuries, may well prove better supported than traditional considerations would otherwise have allowed for.
Full article: Citi Warns “Central Banks’ Grip On The World Economy Is Waning” (Zero Hedge)