Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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August 30, 2023

What Worries Central Bankers


“A billion here, a billion there, sooner or later, it adds up to real money.” Everett Dirksen, US Republican Senator.


Compared to last year’s shot across the bows, Powell’s postcard to investors from Wyoming this year was longer, more measured and less definitive. Indeed his Jackson Hole speech contained something for everyone, but not the punch to the rib cage that last year’s did. For the bulls, he confirmed rates are above the neutral or R* level and, therefore, can reduce in due course; for the bears, he reiterated that they will remain at this restrictive level for as long as it takes.

Last year, after Powell declared that “we must keep at it until the job is done,” financial markets fell into an abyss. Bonds plummeted as US 10 yr. Treasury yields soared, the equivalent Gilt yield nearly doubled, the UK lost its second Prime Minister in three months, the Pound crashed to $ parity, and the FTSE100 lost 10% of its value. It all happened in just six weeks. But, 12 months on, bond yields rose ahead of time, particularly at the longer end, and Powell was less pugnacious.

But while the central bankers warn that we must keep the monetary brakes on, governments have their feet on the fiscal accelerator. The most significant component of increasing government deficit spending is interest. Increased sovereign borrowing costs represent a fiscal stimulus to that part of the economy that owns government debt, boomers and cash-rich corporates.

While monetary policy tightens conditions for the indebted, fiscal policy stimulates conditions for those in credit. Although there are losers in this mix, overall household balance sheets remain, for now at least, in decent shape. Economists inform us we enjoy excess savings. Hence, Powell feels the need to keep rates higher for longer. But in a world of fiscal dominance, he is walking up the down escalator, with the pace controlled by his political masters at the Treasury.

Yet behind Powell’s headlining “steady as she goes” media performance, Jackson Hole’s primary purpose is for central bankers to share ideas from within the rarefied academic world of economics. In this regard, looking down the bill to see who the central bankers wanted to hear from and why is illuminating. The star turns were Darrel Duffie of Stanford and Barry Eichengreen of Berkley, addressing their respective subjects of living with permanently higher levels of government debt and the resilience of the US Treasury market. The clear message from this year’s econ rock stars was to expect more prolonged levels of increased government borrowing combined with increasingly fragile secondary bond markets. In short, the Treasury needs to sell more debt, and the markets have limited capacity to handle it.

Eichengreen added an interesting unnamed reference to Japan in his paper: “Countries where the central bank has purchased the entirety of net new debt issuance over the last decade may have considerably less room to run; in particular, conditions may change abruptly when quantitative easing gives way to quantitative tightening”. A stark reminder that Japanese normalisation represents an under-rated but significant tail risk to global markets.

Duffie’s paper was about the bond market’s inability to cope with the prospective bond issuance tsunami. He said: “Since 2007, the total size of primary dealer balance sheets per dollar of Treasuries outstanding has shrunk by a factor of nearly four. This trend continues because of large US fiscal deficits and regulatory capital constraints, which are necessary for financial stability but reduce the flexibility of dealer balance sheets.” So raising the alarm that the regulatory requirements of the post-GFC era have potentially sown the seeds for the next crisis.

And here it is: the central banks fear burying bond investors with new supply via a market mechanism that had its wings clipped in the aftermath of the GFC. It seems somehow inevitable that regulators must always fight the last war. Capital market preparedness is the new buzzword. This week China quickly responded to concerns voiced by Commerce Secretary Raimondo about the investibility of its markets and promptly cut stamp duty. Quick work compared to the long-running hand-wringing about the de-equitisation of the UK. However, the UK’s review of its equity capital markets capability in the wake of ARM’s inevitable New York listing looks tame compared with what worries the central bankers regarding investor preparedness to absorb the imminent government debt avalanche.


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