The Ugly Truth

Guest Post by Sven Henrich

For years critics of central bank policy have been dismissed as negative nellies, but the ugly truth is staring us all in the face: Market advances remain a game of artificial liquidity and central bank jawboning and not organic growth and now the jig is up. As I’ve been saying for a long time: There is zero evidence that markets can make or sustain new highs without some sort of intervention on the side of central banks. None. Zero. Zilch.

And don’t think this is hyperbole on my part, I will present the evidence of course.

In March 2009 markets bottomed on the expansion of QE1 which was introduced following the initial QE1 announcement in November 2008. Every major correction since then has been met with major central bank intervention. QE2, Twist, QE3 and so on.

When market tumbled in 2015 and 2016 global central banks embarked on the largest combined intervention effort in history to the tune of over $5 trillion between 2016 and 2017 giving us a grand total of over $15 trillion in central bank balance sheet courtesy FOMC, ECB and BOJ:

When did global central bank balance sheets peak? Early 2018. When did global markets peak? January 2018.

And don’t think the Fed was not still active in the jawboning business despite QE3 ending. After all their official language remained “accommodative”  and their hike schedule was the slowest in history, cautious and tinkering not to upset markets.

With tax cuts coming into the US economy in early 2018 along with record buybacks markets at first ignored the beginning of QT (quantitative tightening), but then it all changed.

And guess what changed? 2 things.

In September 2018, for the first time in 10 years, the FOMC removed one little word from its policy stance: “accommodative” and The Fed increased its QT program. When did US markets peak? September 2018.

And with the sugar high of the tax cuts fading it was too much. Add trade wars and global growth slowing it was more than markets could handle.

And so yes, the timing was perfect and you can see it in the chart:

Who ya gonna believe, me or our lying eyes?

Global central banks did the dirty work for the Fed between 2016 and 2017 adding ever more artificial liquidity. But then the ECB slowed their QE program and finally ended it in late 2018.

How did the $DAX handle all that removal in artificial liquidity? Not well.

DAX peaked in January 2018 as the ECB started reducing its QE program.

The Fed likes to claim it is managing policy based on the economy, not on markets. But here’s the ugly truth on that: The economy these days is very much tied to market performance. Big drops in markets have an adverse impact on the economy full stop. Hence it is a fallacy to argue that one looks at one but not the other.

After all, tell me when the Fed ever hikes during a massive market correction? The answer: Never. It’s always the other way around.

As soon as markets drop all plans for rate hikes and/or balance sheet reductions come to a sudden halt:

Recognizing the market’s sudden found sensitivity to QT the Fed was sure to react. After all markets were sensitive to slowing growth in China, $AAPL’s warning this week and the renewed sell-off in markets as a result.

And what did we get this very morning? The predictable jawbone:

Powell says Fed ‘wouldn’t hesitate’ to tweak balance sheet reduction

“We don’t believe that our issuance is an important part of the story of the market turbulence that began in the fourth quarter of last year. But, I’ll say again, if we reached a different conclusion, we wouldn’t hesitate to make a change,” he said. “If we came to the view that the balance sheet normalization plan — or any other aspect of normalization — was part of the problem, we wouldn’t hesitate to make a change.”

Bullshit. Of course it is and he knows that and he dangled the carrot and that’s all that mattered.

Who ya gonna believe, me or our lying eyes?

This move came on the heels of China’s overnight intervention announcing a coming cut in its bank reverse ratios by 1%.

So don’t mistake this rally for anything but for what it really is: Central banks again coming to the rescue of stressed markets and their action and words matter in heavy oversold markets.

But the reality remains, artificial liquidity is coming out of these markets:

Although the Fed, as indicated by Powell may slow or even halt their projected path. On a dime. And that’s what markets are reacting to today.

Central banks keep claiming all this is done to support growth. What growth? What has actually been accomplished?

All this intervention has not produced sustained accelerating growth, certainly not compared to previous cycles.

Tax cut sugar high aside all growth projections for 2019 are pointing to marked slowing with recession risk rising.

The only thing that has really grown as a result of all this cheap money and intervention is debt:

Corporate debt has doubled since 2007. Government debt is expanding with no end in sight having risen by another $2 trillion in the first 2 years of the Trump administration.

And so here we go again:

And central banks have already begun to react.

What’s the larger message here? Free market price discovery would require a full accounting of market bubbles and the realities of structural problems which remain unresolved. Central banks exist to prevent the consequences of excess to come to fruition and give license to politicians to avoid addressing structural problems. And by preventing these market forces from playing out at each sign of trouble the can gets kicked further and further down the road. Each successive recovery keeps the illusion alive but the jingle is getting tighter and tighter each time around and requires ever lower rates before the monsters return. In the meantime debt keeps expanding while each recovery produces less and less organically driven growth, but ever higher wealth inequality. This is what this system produces.

And that’s the ugly truth. But you won’t hear it from the Fed.

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