The world’s major central banks are trapped in a reality that only looks “more or less good” if they do not run away from this permanent monetary injection, with reference rates at zero or even negative and curves of yields in the long part collapsed at levels absolutely unthinkable.
Almost all curves for European sovereigns today are in negative territory. What was novel at some point, “Bernanke’s QE1”, is today a global monetary trend that is even called “the new monetary policy”, As if broadcasting to infinity had something new.
It has been writing a dangerous chapter in monetary policy, which has reached historic levels with respect to its formidable distortion capacity that has even affected basic correlations between gold, US Treasury bonds and stocks.
The new liquidity trap
The Federal Reserve and now several central banks of the world are caught up in their own creation, which would appear to be the “new version of the liquidity trap”, a much more perverse one in which any central bank that decides to be orthodox risks the end of the reflation and therefore, the potential onset of systematic chaos related to collapse in financial asset prices.
If they “run” from so much monetary lightness the market corners them by selling strong with a VIX in the clouds and again an almost endless sequence of Free Puts implicitly issued by the main G10 central banks.
Long ago, when the US economy was showing symptoms of a very slow recovery, it was debated whether the Federal Reserve had reached its stimulus limit. Recall that at that time its reference rate was at 0% so “technically” it could not go down any further from that level. At the time, it was thought that the real economy should find its course alone and without further help from the Fed since it “had no more bullets.”
However, since then the Federal Reserve of Ben Bernanke and now from Jerome Powell, embarked on non-traditional and ultra-expansionary monetary policy and via his four QEs he took care of continue to stimulate an asset market that seems to have no limits to reflation.
The QEs of the 2008/2014 crisis have preferably gone to buy long bonds with the aim of collapsing long-term rates in an attempt to stimulate home financing. However, with QE4 implemented months ago by Powell, given that the yields of the bonds are almost zero, the market this time, decided to reflate almost entirely by the markets of equity, especially technological actions and even after the fierce correction that they exhibited these days.
Literally, the Federal Reserve wiped out the risk-free bond market by eliminating a classic investment alternative for the saver. Now said saver is forced to position himself in a totally different monster: equity, with all the volatility and insanity that this implies.
The 2008/2014 strategy and “the mother of all traps”
Previous rounds of QE implemented between 2008/2014 attempted to impact the real economy in three fronts:
- a) yields long declines stimulated investment,
- b) dollar weakness North American competitiveness increased via exports,
- c) wealth effect via reflation of financial assets It made you feel “nominally” richer, stimulating consumption.
As the S&P and Nasdaq broke records time and time again, the global economy had been exhibiting a performance pretty mediocre forcing a generalization of the measures originally adopted by the Federal Reserve.
And after all this appeared the Covid-19 and erased with a stroke what until then was conceived as “aggressive” monetarily speaking. The monetary decisions adopted since then far exceed in magnitude and speed what was done in the previous crisis.
Therefore, it could be conjectured that previous QEs allowed the Fed to escape the liquidity trap the one it had reached when its benchmark rate hit 0%. The QEs were arguably the way out of the original “zero rate” trap.
But the interesting thing is that The Fed may have dodged a short liquidity trap to enter another long liquidity trap, exacerbated by multiples now given what acted on by the pandemic.
This last trap, “The mother of all traps” may be bubbly schizophrenic, even more so because this way of doing monetary policy became general worldwide, facing us today situations at risk of deflation and quasi-recessions.
The second trap
The Fed in particular he knows that if he goes just a little bit of the thread, the steepening in the long part of the curve can be aggressive enough to challenge everything advanced at the collapse level in global risk.
Precisely here is the second trap, now in the dimension of heterodox monetary policy, a trap in which not only is the Fed now but also an increasing sequence of centrals oriented by preserve scarce employment that tries to survive the impacts of coronavirus.
We can be watching a group of central banks that, although they managed to escape the liquidity trap of 2008, may well begin to get caught up in their second and magnanimous creation: huge QEs and everywhere in the G10.
There is an entire market dependent on QEs, very used to not “hedgear” nothing and very ready to cum at the slightest lack of monetary complacency.