donderdag 6 juli 2017

Albert Edwards: "Something Smells Different This Time"

In his latest note, SocGen's permaskeptic Albert Edwards looks back 20 years in time to the Asian Crisis, and makes an interesting observations: nothing has really changed. In fact, as he explains, the events over the past 2 decades have been a "linear progression of the monetary madness that followed the 1997 Asian", and all thanks to central bankers who used the crisis as a springboard for ever more drastic monetary interventions, resulting in one bubble after another, culminating with the current state of the world, to wit: On the 20th anniversary of the start of the Asian crisis it is certainly clear to me that the mess we are now in is a linear progression of the monetary madness that followed the 1997 Asian bust. Each and every subsequent economic and financial hiatus has been a direct result of excessively loose monetary policy to clear up the previous mess. The current perilous state of the global financial system is evident to anyone who scrapes at the cheap veneer of normality. I was cheered last week when the BIS called out the current conjuncture. They were one of the few institutions in the mid-2000s to accurately predict the impending financial crisis, and they fear another crisis is close.
Following his 20-year look back, Edwards then recounts the dramatic events of the past week, saying that "It took only a few days after my last weekly, which focused on the likely loss of independence for central banks in the next recession, for them to come out swinging. It only took a subtle change of rhetoric to prompt a mini-taper tantrum. It seems increasingly clear the Fed, the ECB and even the Bank of England (BoE) wish to get on with their tightening cycles, however far behind the curve they might now be." Meanwhile we are forced to watch the embarrassing spectacle of central bankers measuring the ‘success’ of their forward guidance by the subsequent lack of market volatility. Seeing the ECB spokesperson scurrying around to soothe upset markets in the wake of Draghi’s speech shows the tail is surely still wagging the dog. But something seems to have changed in the Fed’s way of thinking. And while the market remains unbothered by the bout of hawkish rhetoric, perhaps convinced that the next time stocks slide even modestly the Fed will immediately come to their rescue, Edwards disagrees: "Is it conceivable that the Fed is no longer so data dependent and doesn’t care how strong the economy is or whether wage inflation is going to pick up? Many commentators seem to think the Fed will simply back off tightening as soon as the going gets rough, as it has consistently done in the past. But something smells different."
# As justification for why this time it may be different, Edwards cites last week's gloomy BIS report which "unlike central banks who merely give a casual shrug of the shoulders when asked about the impact of their ZIRP and QE policies on debt and asset bubbles, the BIS is really very concerned that policy makers are making exactly the same mistakes they did in the run-up to the 2008 financial crisis. In what can be regarded as the clearest warning possible, if not a direct rebuke to current central bank timidity and gradualism, the BIS Chief Economist, Claudio Borio said “The end may come to resemble more closely a financial boom gone wrong, just as the latest recession showed, with a vengeance. A strategy of gradualism is no panacea, as it may encourage further risk-taking.” He went on, “Leading indicators of financial distress point to financial booms that in a number of economies look qualitatively similar to those that preceded the great financial crash.”
However, the countries at risk are not those that were at the centre of the previous crisis, such as the UK. Instead he pointed to economies such as Canada and Sweden that largely avoided the last crash but have since allowed huge borrowing and property booms that make their economies vulnerable. The largest emerging economies of China, India and Brazil are also vulnerable after a period of rapid growth, much of it based on cheap credit. I think the BIS could go even further. Certainly the IMF warned a few weeks ago very loud and clear that the US corporate debt bubble leaves 20% of companies vulnerable to default as interest rates rise.
As for the UK, the recent slump in the savings ratio from over 6% a year ago to a record low of 1.7%, bodes ill. By contrast the US household savings ratio has surged to an eight-month high of 5.5% (remember measured on the same basis as the US, the UK savings ratio has already slumped deep into negative territory. Of the major economies, only the UK, France and Portugal overstate their household savings ratios by reporting them gross of depreciation of the housing stock. Edwards the notes the recent shift in sentiment among other central banks, but notes that "it is the Fed that really seems to have got the tightening bit between its teeth. I, like many others, have been scratching my head as to what really has changed in its thinking from this time last year. Certainly not the data!"
# The answer according to the savvy John Mauldin may be that the Yellen Fed is no longer data dependent, but is instead thinking of its legacy. He points out that with three of the seven Washington Fed appointees currently awaiting nomination by President Trump and the likelihood/probability of additional personal churn ahead (including Yellen and Fischer), the existing Washington Governors are trying to get rates up towards ‘normal’ before they leave office, almost irrespective of the inflation or economic data. John writes in an appropriately titled piece Mad Hawk Disease Strikes Federal Reserve, “I believe a faction on the FOMC wants to cement its own preferred policies in place and make it difficult or impossible for a new majority to change course in 2018 or thereafter. Yellen, Fischer, and Dudley all seem to be of that mind, and they are now taking a hawkish approach to monetary policy. That’s why they don’t want to do the otherwise sensible thing, which is to wait for more evidence that inflation is a problem before tightening further”...

# The SocGen's strategist concludes by pointing out an alternative theory, first presented on this site, which he says "is even more desperate for investors", namely that proposed by BofA's Michael Harnett at Bank America who "believes that the Fed has become increasingly concerned about the inequality QE has produced." It had been willing until recently to run the economy hot in the expectation that this would produce wage inflation for Joe Sixpack. That hope has been disappointed and “the Fed has two ways to cure inequality, you can make the poor richer, or you can make the rich poorer". And recent events make Michael think the Fed has now abandoned the former and opted for the latter. "There are going to be some very surprised investors out there." The only difference is that this time the bulk of the investors will be of the robotic, algorithmic kind....

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