Jawboning & Volatility – Settle in…

The much anticipated speech from US Fed member Brainard last night delivered yet another surprise when she came out dovish when, after Rosengren Friday night, many were expecting a change to the hawkish side and more hints at a September rate hike.  The reaction was therefore predictable in that it was almost the reverse of the Friday night rout.  The S&P500 regained 1.5% of the 2.4% it lost Friday night, bond yields dropped, gold and silver rose, and the USD fell.  Yesterday saw $35b wiped off our ASX in the biggest one day fall since Brexit, and leaving it back to zero gains for the year.  If our market follows the US then we could see some of that reversed today. For now…

Brainard’s speech called for “prudence” in removing monetary accommodation and said the case for tightening was “less compelling” given the lack of inflation and a less than convincing economic recovery.  In a warning for Australia as much as the US she said "China is undergoing a challenging transition from a growth model to one driven by consumption".

And so welcome back to the jawboning we saw in the protracted lead up to the end of QE3 and then the first US rate hike last December.  The Fed knows a rate hike will cause chaos, but they also know it is necessary as this credit cycle appears out of control.  So they need to get the market as conditioned with words as possible.  The odds for a September rate hike, after spiking Friday night, are now back down to just 11%.

However one would be foolhardy to think it’s back to easy-money-situation-new-normal for good.  Last week and Friday night may still mark a change in tact by the world’s central banks as we discussed yesterday.  Friday night showed how sensitive easy money addicted markets are to such a change, even if just mooted.  So such volatility and jawboning by central banks may be around for a while as they try to transition.  Now more than ever, a balanced mix of assets in your portfolio is critical.  Some theorise this is the ‘death throws’ at the end of this epic credit cycle that started in the early 70’s.

Some 2 years ago we quoted Joseph Baratta, Global Head of Private Equity at the Blackstone Group, the biggest fund manager in the world.  Back then he said:

"We are in the middle of an epic credit bubble, in my opinion, the likes of which I haven't seen in my career in private equity."

Yesterday the CEO of one of the world’s biggest banks, J P Morgan, said the Fed should just get on and raise rates.  Of course higher rates are more profitable for banks, so he would…  Interestingly though, on the same day one of his senior execs said:

“the current credit cycle is unlike any the bank has seen”.  

Sound familiar?  That, from 2 of the world’s largest financial institutions.

There is no easy way out of a credit cycle.  Central banks have inflated what many think are now an out of control asset bubbles through monetary stimulus gone too far.  Should, as many now believe, governments now move to unleash unprecedented fiscal stimulus instead, that still requires more debt and/or printed money to do so.  It is not a solution, it is a final throw of the dice.  Get used to the jawboning and volatility until it ends.