The times when analysts, traders and portfolio managers had to process huge amounts of information, produce country, regional, industry and God knows what else analysis has gone.
This is nonsense for modern market participants, and for successful trading it is enough to read the reports on the dynamics of the Fed balance and closely monitor
for the actions of the Central Bank of China. The news background no longer influences the dynamics of stock indices, and the reaction to negative news is at best immediate and short-term. In today’s article we will talk about
how markets change their behavior by responding to the Central Bank.
Since the last financial crisis and the subsequent longest bull market in history, the role of central banks has changed dramatically: the Fed, the ECB, and the People’s Bank of China are the only remaining forces that are trying to fight depressed global economic growth. The truth is, often shooting sparrows with a cannon, creating bubbles in financial assets and unrealistic price distortions, and looking at which one unwittingly wonders whether objective economic laws are still in place or whether regulators have simply repealed them.
Changes in monetary policy affect the real economy lagging behind, however, the announced decisions of regulators are instantly reflected in the prices of financial assets in real time. That is, no positive effects have yet occurred in the real economy,
and investors can already fix profits from things that have not yet happened and may never happen.
Today, it is solely the actions of the Central Bank that determine the trajectory of all asset classes, which is increasingly moving away from reality.
Apply the dynamics of the Fed balance to the S&P500 chart, and no other arguments will be needed.
Signs of influence
Characteristic features of the modern financial system, which emerged as a result of long-term ultra soft monetary policy of world Central Banks:
- Historical records of global debt
- Huge balances of central banks
- Low long-term interest rates
These signs are a completely new paradigm, and they are also essential risk factors in the face of the current total uncertainty.
All this has made regulators more dependent on capital markets than ever before. And the recent fluctuations of the Fed are a clear demonstration of this.
After a sharp correction of stock indices in the 4th quarter, the Fed changed the US monetary policy dramatically – the market is already laying the groundwork for lower interest rates, a halt in balance-sheet contraction and the prospects for liquidity provision rather than withdrawal.
Though, of course, we see some alarming signs of worsening of the situation. For example, from December 2018 to February 2019, the states have seen negative growth in industrial production. Retail sales declined and the ratio of stocks to retail sales increased.
Recently, statistics have recorded a decline in personal income and expenses.
The leading index of the Philadelphia Federal Reserve Bank has been declining since January 2017. And so on. Perhaps, the Federal Reserve is ahead of the curve, but now there are no bullets in their clip. The current rates are too low for their reduction to have had any stimulating effect on the economy.
As a result of the return of interest in risky assets, the S&P 500 has reached unimaginable levels of overbought, which provokes an increase in commodity prices.
(primarily oil, which increased by 40% in the last quarter), and as a result, inflation will accelerate. The Fed will have to resume the cycle of rate increases, while the stock market is waiting for a collapse, as now the market lives with very different expectations.
Logic of events
The fall of the stock market in Q4 caused panic in the Fed. Just imagine if as a result of the coke margin, the debt pyramid starts to collapse? Further, the regulator changes the tone dramatically: the market is rising and prices for raw materials are rising, which provokes inflationary expectations. Somewhere in June of this year, the Fed starts to raise rates again. With some temporary lag, the bubble on the stock market burst.
Analysis and consequences
But even this is not the main thing or the most interesting. The University of Chicago recently published a paper by Ernest Liu, Atif Mian and Amir Soofi entitled “Low Interest Rates, Market Power and Productivity Growth. In fact, it’s a conviction of all Central Banks. The paper explores how firms behave in a competitive market while reducing motivation and demonstrates that while lower interest rates initially increase competitiveness through increased investment, they also increase the comparative advantage of larger firms, which over time prevents smaller firms from investing and makes the market less competitive.
If low interest rates persist and approach zero, eventually even larger firms stop investing because they are no longer highly competitive and therefore do not need to invest. This, in turn, undermines the foundations of a market economy.
Ultra low interest rates cause an unprecedented decline in productivity growth and kill competitiveness.
This is the same “bomb” that regulators have put into the market mechanism. This conclusion draws on the Nobel Prize for Economics.
The authors make a scientifically grounded conclusion: ultra low interest rates in Japan,
the euro area, the UK and the USA were closely linked to an unprecedented decline in growth rates
of productivity in these countries.
In all high-income industrialized countries, where interest rates remained artificially low after 2008, productivity growth had already virtually stopped by 2016 or was close to zero. The worst effects were observed in the euro area and the United Kingdom, where inflation continued, resulting in a sharp decline in real interest rates. Even in Japan, where interest rates were kept at artificially low levels for two decades, productivity deteriorated significantly after 2009.
The theory of the University of Chicago postulates that small businesses with ultra-low interest rates simply stop investing or even stop being created as businesses. And this is the foundation of a market economy. It was not until 2018 that the positive performance indicators became clearer as interest rates went up against inflation in the US, although still below their healthy historical levels.
In today’s economy, central banks have become too involved in the process of creating money and setting interest rates, and have artificially set rates outside their natural level, with investment decisions becoming distorted and sub-optimal. In this situation, productivity growth will inevitably decline.
If the distortion of the interest rate curve is prolonged, the productivity growth may even disappear as the investment is directed into completely wrong assets. As a consequence, there are bubbles in real estate markets and huge debts of all kinds by historical standards. Default rates on all these debts are starting to rise and will inevitably lead to huge losses, it is only a matter of time.
Ben Bernanke’s crazy and irresponsible idea of throwing money from helicopters in 2002, expressed at a meeting of the National Club of Economists, has become one of the most economically destructive ideas in history. Interest rates are the central variable in a well-functioning capitalist system. Interfering in this market process, politicians and bureaucrats are trying to act like the Gosplan, the central planning agency of the Soviet Union, the consequences of the Gosplan are still remembered by many.
And these are not good memories.