Courtesy of Mish.
Central Banks and the Business Cycle
I like it when someone besides a few financial bloggers takes the gloves off and starts asking some hard-hitting questions.
In Cross Asset Research last week, Albert Edwards at Societe General did just that. Emphasis in italics is mine.
Fragile and vulnerable in itself, the US recovery now battles against the rest of the world, which like a horror movie is dragging it down into a hellish Ice Age underworld. The problem is that at these stratospheric valuations, the market does not need to suffer an ACTUAL recession to see a crash. Like October 1987, just the fear of recession will be enough to trigger a massive market move.
On these pages we have a very simple thesis as to what will bring an end to this grotesque, QE-fueled market overvaluation. Simply put, the central banks for all their huffing and puffing cannot eliminate the business cycle. And they should have realised after the 2008 Great Recession that the longer they suppress volatility, both economic and market, the greater the subsequent crash. Will these morons ever learn?
The problem is that most risk assets, and especially equities and corporate bonds, are very expensive and priced for a long cycle. Meanwhile, this recovery has failed to generate any cyclical upward pressure to inflation – indeed quite the reverse. The global economy resembles a knackered old V8 engine which is now only firing on one cylinder (US). Hence, any data suggesting that the US economy is now also flagging were always likely to cause a meltdown as investors feared the imminent arrival of Japanese-style outright deflation. We note with interest that US 5-year inflation expectations in 5 years’ time have not fallen anything like as quickly as 5y expectations (see chart below). This suggests to me a continued misplaced market (over)-confidence about central banks’ ability to control events.
Only one day before last Wednesday’s flash crash, Guy Debelle, head of the BIS market committee, said investors had become far too complacent, wrongly believing that central banks can protect them, and many staking bets that are bound to “blow up” at the first sign of stress. A market loss of confidence in policy makers’ ability to control events has always been part of our Ice Age thesis. US inflation expectations in particular will fall an awful long way if investors fear the US cycle is about to fail.
I have always thought that this would all end the way Christopher Wood explained in his GREED and fear publication last November: “The key issue is what might trigger a market correction . The market consensus continues to focus on the tightening in financial conditions triggered by “tapering”. Still such a hypothetical correction is not so big a deal to GREED & fear, since any real equity decline caused by tapering is likely to lead, under a Fed run by Janet Yellen, to renewed easing. The real threat to US equities is when the American economy fails to re-accelerate as forecast”. Certainly, in my view , at these elevated valuations, it will not take much to bring down the entire ‘pyramid of piffle’.
Other Economic Illiterates
Just two days before Albert penned the above, a reader sent me a link to the Salon article America’s ugly economic truth: Why austerity is generating another slowdown by David Dayen.
Austerity amid recovery has been a disaster everywhere it’s been tried, and the fact that America’s course looks better right now than the more calamitous policy choices in Europe or the rest of the world brings little comfort. Anyway, a global slowdown, which appears to be the current path absent concerted action, will inevitably hit us at home.
David Wessel of the Brookings Institution is right to say that this terrible outlook for economic growth represents a choice by policymakers. With borrowing costs once again near historic lows, Congress could simply decide to finance some more investments. Europe could finally put an end to the economic straitjacket it’s chosen to wear for over half a decade. That dreaded dirty word – “stimulus” – could be employed once again.
US vs. Europe
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