vrijdag 14 juli 2017

BofA Lashes Out At The Fed: "Take That Punch Bowl Away" Or Face A Crash

In a dramatic appeal for rationality at the Fed, Bank of America's global FX strategy team today released a note titled "take that punch bowl away", which laments that while central banks backtracked from their hawkish recent rhetoric this week, it warns that "they will be sorry if they allow bubbles" and predicts that vol will increase this fall adding that the bank remains "cautious and selective in EM FX, despite the Fed-triggered rally this week." The note comes 24 hours after BofA's chief strategist Michael Hartnett warned that "the most dangerous moment for markets" will likely come when "rising rates combine in three or four months’ time with an inflection point in corporate profits. In anticipation of this, we would use the next couple of months to buy volatility, and within fixed income slowly reduce exposure to IG, HY, and EM bonds"...



Of course, Hartnett's report is based on the assumption that the Fed will do what Yellen has threatened to do and hike at least once more in 2017, the "right thing." But what if the Fed once again backs away from its plans to burst the asset bubble as all of the top FOMC members were loudly warning they would do just three weeks ago? Well, things will get much worse, as BofA's unexpectedly objective analysis of the bubble the Fed has blown in recent years, details: The global crisis shifted debt from the private to the public sector, which now encourages high savings and leads to low interest rates. Population is aging in many countries, also supporting saving. And technology is a positive supply shock, leading to lower prices. High savings and low inflation keep central bank policies loose. Loose monetary policies in turn support risk assets. Equities are at historic highs and vol at historic lows, even more this week following a dovish tone by Yellen in her Congress testimony. Here Vamvakidis echoes Hartnett and says that in his, and his bank's view, "we do not believe that this is sustainable, and we have been arguing that we will see the beginning of the end of this new not-so-normal market this fall."
For those who have missed our coverage of Hartnett's weekly laments, BofA's FX team recap the bank's thinking of why the Fed and its central bank peers have been so aggressive in following a hawkish tone, despite economic data which continues to disappoint: Central banks getting more concerned that they are fuelling asset price bubbles. We got a taste of this in recent weeks, with a number of central banks talking about loose financial conditions despite low inflation and the need to normalize monetary policies, but there was some backtracking this week. Our global investment strategists believe that central banks will act to pop the bubble later this year. The unwinding of central bank balance sheets itself will gradually reduce their role in global markets. This role has been a distortion, as it represents strong demand for assets that is inelastic to fundamentals.
The Fed is about to announce plans to start unwinding its balance sheet and the ECB is about to announce plans to first taper and then end its QE program. We believe both will help bring back some normality in fixed income markets. Amen... only that may not happen if history is any guide. In which case what is an already bad situation will only get much worse. BofA explains: If we are wrong and central banks do not take away the punch bowl, things will get much messier eventually. “Bubbles” may form that will eventually burst, leading to much higher volatility than necessary. Keeping rates low in response to persistent positive supply shocks that keep inflation low could lead to imbalances, with a painful eventual correction. Central banks did this mistake before the global crisis and kept monetary policies too loose as inflation was low, ignoring very easy financial conditions, excessive and sometimes irresponsible credit expansion and a housing price bubble. We do not believe, or at least we hope, they will not repeat the same mistake twice. Unfortunately, with $15+ trillion in DM central bank liquidity backstopping the market, the threat of a crash is all too real, just ask Jamie Dimon, once the unwind begins. Which is why Janet Yellen, concerned about her legacy, may get cold feet in the last moment and to precisely that: "repeat the same mistake twice." 
That said, all hope is not yet lost: recall that the catalyst the spurred the hawkish Fed was the assumption that monetary policy would be able to hand off risk asset support to fiscal policy. However, with Trump now mired in Russian collusion scandals, the possibility of some fiscal boost deal emerging is virtually nil. There is still hope for tax reform in the US. Everyone agrees that the US badly needs it. Our corporate survey suggests that US corporates remain hopeful. However, our Global Fund Manager Survey and our Rates and FX Sentiment survey suggest that investors have given up. If it does happen this fall, many of the so-called Trump trades will come back. Our corporate survey also suggests that the share of non-USD assets that US companies keep abroad is much higher than consensus estimates, which could lead to a much stronger USD from repatriation following tax reform.
Finally, there are other risks: There are always potential shocks from unknown unknowns. Our survey data suggests that cash balances are not low, but we believe investors are waiting for market dips to buy. We believe that the market is not hedged for unexpected shocks, or implied volatility would not have been so low. The VIX index is reaching levels again from which the risks are mostly to the upside based on its history. Oh well, at least there is a new generation of traders preparing actively for this worst case scenario, right? Well, not really. Amid what has emerged as one of the most boring markets in history. One bond trader who spoke with Bloomberg said he’s been slipping out early to watch his kids play sports. A fund manager says his office just staged a golf retreat. And a trading supervisor at another bank confided that he’s spending more time swiping through potential romantic partners on the dating app Tinder. And speaking of tinder, if BofA is correct, that's precisely what "markets" have become, now just lying in wait for the next lit match....