The central bankers who saved the world economy are now being told they risk hurting it.
Even as the International Monetary Fund cuts its global growth outlook, a flood of stimulus is running into criticism at the World Economic Forum’s annual meeting in Davos. Among the concerns: so-called quantitative easing is fanning complacency among governments and households, fueling the risk of a race to devalue currencies and leading to asset bubbles.
“Central banks can buy time, but they cannot fix issues long-term,” former Bundesbank President Axel Weber, now chairman of UBS AG, said in the Swiss ski resort. “There’s a perception that they are the only game in town.”
Quantitative easing “is one of the greatest monetary experiments of all time, they’ll be writing books about it for a thousand years,” said JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, who is also in Davos.
Warnings about a new money glut are not going unheeded. U.S. Federal Reserve Chairman Ben S. Bernanke said Jan. 14 that officials must “pay very close attention to the costs and the risks” of emergency stimulus. Bank of England Governor Mervyn King said last week “the search for yield appears to be beginning again.”
Nouriel Roubini, the New York University economist noted for his pessimism and accurate prediction of the global financial meltdown, is worrying these days about the long-term impact of easy money policies by central banks.
Roubini said the quantitative easing (QE) programs pursued by the Federal Reserve and other central banks may overwhelm the economy with debt-strapped banks, businesses and consumers, according to The Guardian.
“Over time, you get zombie banking, zombie corporates, zombie households, which is damaging in the long term,” he told an audience at the World Economic Forum in Davos, Switzerland. Zombie banks refer to financial institutions that are insolvent but are propped up by cheap money from the government.
BofA Warns of 1987 and 1994 scenarios
For a while now, BofA Merrill Lynch Chief Investment Strategist Michael Hartnett has been out in front of the rest touting the “Great Rotation” theme for 2013 – and he says it’s already begun.
Even though the public data don’t show investors shifting out of bonds and into stocks yet, Hartnett says BofA’s data on client position does show exactly that.
In a new note, Hartnett writes (emphasis added):
The past seven years have seen a Great Divergence in terms of fund flows. Investors have poured $800bn into bond funds and redeemed $600bn from long- only equity funds. But recent data show the first genuine signs of equity-belief in years. The past 13 days have seen $35 billion come back into equity funds ($19 billion of which is via long-only).
And while the industry flow data does not show “rotation” out of bonds, our private client data does. The structural long position in fixed income is simply threatened by low expected returns thanks to low rates and the mathematical reality that a small rise in rates can cause total return losses in portfolios. Table 1 shows that negative returns would occur if the 30-year Treasury yield rose from 3.03% to above 3.26% anytime in the next 12 months (and note the same yield was 4.53% just 3-years ago).
However, there are still two big risks to an “orderly” rotation out of bonds and into stocks this year, in Hartnett’s view. He says the possibilities of either a “1994 scenario” or a “1987 scenario” jeopardize a smooth transition:
The current level of US jobless claims (335K) is the lowest since Jan 2008, when the unemployment rate was just 5.0%. If the global economy and corporate animal spirits revive sufficiently to cause an upward surprise to US payroll numbers in coming months, say numbers in excess of 300K, then a repeat of the 1994 “bond shock” is likely. In recent months we’ve drawn a number of comparisons to market returns in 2012 and 1993, the last year banks assumed major global leadership. In 1994 the combination of stronger-than-expected payroll, a tighter Fed, a 200bps back-up in yields led to a big pause in the nascent equity bull market and a savage reversal of fortune in leveraged areas of the fixed income markets (e.g. Orange County & Mexico). Investors banking on economic recovery should therefore be reducing longs positions in High Yield and EM debt.
In contrast, in 1987, rising risk appetites caused equity prices to drag bond yields higher. At the same time, policy tensions over currency valuations between Germany and the US also put upward pressure on bond yields, as well as gold prices. Ultimately the combination of policy risks, rising gold and bond yields helped precipitate the October crash in equity markets. A repeat of 1987 is a low probability event in 2013. But it is also clear that risk appetite is on the rise, many countries are trying to devalue their way to growth, risking a currency war, and should gold start to respond favorably to this backdrop, we would certainly worry that a major risk correction is imminent.
A U.S. housing-market revival may prove illusory and the threat of further weakness remains, said Robert Shiller, a professor at Yale University and co-creator of the S&P/Case-Shiller index of property values.
“The housing market has been declining for something like six years now, it could go on, that’s my worry,” Shiller told Tom Keene in a Bloomberg Television interview Thursday in Davos, Switzerland. “The short-term indicators are up now, it definitely looks better, but we saw that in 2009.”
The property market has shown signs of recovery and homebuilding has rebounded as low borrowing costs spur buyer demand, bolster prices. Values rose 7.4 percent in November from a year earlier, the ninth straight increase and the biggest gain since May 2006, Irvine, California-based data provider CoreLogic said last week.
“We’ve been five years in a slow economy, and it could go quite a bit longer,” he said. “We’ve seen gross domestic product growth at sub-normal levels.”
He added, “I think we’re pretty far from irrational exuberance, maybe 50 years away.”
Bill Gross, founder & co-chief investment officer of bond giant PIMCO, said on Wednesday that his firm is limiting its usage of derivatives & that global stocks are attractive in light of coming inflation.
NEW YORK: Bill Gross, founder and co-chief investment officer of bond giant PIMCO, said on Wednesday that his firm is limiting its usage ofderivatives and that global stocks are attractive in light of coming inflation.
“We’re basically becoming more and more of a cash-based type of manager as opposed to what the concept is of derivatives,” Gross said Wednesday at the ETF Virtual Summit in Irvine, California.
PIMCO, Pacific Investment Management Co., had $1.92 trillion in assets as of September 30, 2012. Derivatives have long been a staple of the trading strategy in Gross’s PIMCO Total Return Fund, the world’s largest bond fund with over $285 billion in assets.
It’s Official: Worst. Recovery. EVER
If there was any debate whether the Fed’s policies have helped the economy or just the market (and specifically the Bernanke-targeted Russell 2000), the following two charts will end any and all debate. As the following chart from the St Louis Fed shows, as of the just completed quarter, US GDP “growth” since the “recovery” is now the worst in US history, having just dipped below the heretofore lowest on record.
A slightly prettier version of the same chart created by JPM’s Michael Cembalest, is presented below:
Kansas Fed Joins NY, Philly And Richmond Fed In Contracting; Employment Index Drops To 2009 Levels
Kansas City Fed Employment Subindex…
- City, State balance sheets face $11 billion in unfunded retirement (Alaska)
- Japan trade deficit soars to record $78.3 billion
- Japan’s Metal Smelters See 12 Billion Yen Cost Rise on Power
- Greece to Use Emergency Decree Order to Stop Athens Metro Strike
- State considers university tuition hikes (Connecticut)
- Rising bad loans signal more pain for Spanish banks