Big Picture : Monthly Edition

In today's Big Picture series we discuss dominant macro themes that we think have been responsible for driving markets and asset classes thus far this year.

Opening statement:

Central Banks are suppressing yield curves by introducing forward guidance into their rate cut outlooks. The combined increased tolerance of above target inflation and yield curve suppression, along with investor expectations of a soft landing in growth is boosting prices of assets across various classes.

Liquidity is increasing:

Whether you look at price action in Nvidia, or the strong rally in Bitcoin there are increasing signs that liquidity is ample in the market and perhaps even increasing.

The Bank of Japan is still buying 60 Billion dollars a month in government bonds, the Fed is set to reduce its pace of QT by approximately 30 Billion dollars, the Swiss National Bank will stop its sale of foreign assets in order to strengthen the Swiss Franc and Chinese stimulus should ultimately amount to 5% of GDP, or roughly 1 trillion dollars.

Central Banks are increasing the size of their Gold Reserves and investors seem happy to take risks in markets where liquidity is ample and monetary policy is becoming increasingly supportive of growth.

Yield Curve Suppression

Central Banks are telegraphing their intention to reduce real interest rates and have been publishing their versions of what interest rate policy is likely to look like two years forward.

Telegraphing your intentions in this way is providing markets with a form of monetary “forward guidance”. This form of “forward guidance” is suppressing yield curves which in turn is providing a monetary boost to the economy.

Credit lending and risk seeking behaviour in the real economy and financial markets tends to function partially via the expectations channel. If interest rates are “expected” to come down, economic agents can feel that much more confident that economic conditions will remain rosy. This boost to overall confidence has the impact of making monetary policy feel “less restrictive” than what it otherwise would have been had central banks NOT communicated their intention to ease monetary policy. Long-term interest rates remain anchored and bond volatility declines which additionally underpins growth.

Inflation tolerance

Core inflation, as measured by the Fed’s preferred inflation gauge, seems to be settling into a 2.5% to 3% range based on data released thus far this year. Coincidentally, inflation expectations as reported by the University of Michigan’s consumer report clocks in 5yr inflation expectations also at 2.8%. Long-term break even inflation rates have climbed up this past month settling in at around 2.3%, trading firmly within a 2% to 2.5% range.

Overall the Fed seems comfortable with its inflation outlook despite some signs of a short term uptick. Market participants have accepted this reality and are investing in a way that helps them potentially take advantage of easier monetary policy while at the same time protects them from a 2.5% to 3% inflation rate.

Conclusion:

Liquidity is ample, yield curves are suppressed and higher short-term inflationary pressures are being tolerated. Barring a significant growth shock or a policy U turn by the Fed, recent asset market trends are likely to continue as investors seek to both generate returns and protect themselves from inflation volatility.

A more purist approach could have seen official policy held tighter until inflation rates had clearly begun to trend at or near 2%. That approach however would have meant taking a larger hit on the growth front this year and a higher tail risk of a significant deleveraging event down the line.

At this stage, policy makers don’t think it necessary to take on that added risk and instead will continue to patiently signal their intentions and bide time until short-term underlying inflationary pressures subside.

Asset bubbles may form in certain areas in the meantime but central banks will see the occurrence of that beyond their control for now.

Let us see what the month of April brings.

As Always, we shall keep you posted here at Purity Macro.

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Disclaimer

The information provided in this post is for general use only and does not constitute a solicitation for investment. It should not be construed as professional financial advice. Seek independent professional consultation before making an investment decision.