Yesterday we felt like a brief moment of gloating was deserved, when we noted that, based on the WSJ’s reporting, the somber mood among Davos “prominent investors” and billionaires was “irritated, bordering on affronted, with what they say has been central-bank intervention that has gone on too long…. from this anecdotal sampling, at least, that has created growing distortions in nearly all asset prices—from stocks to bonds to real estate.”
In other words, precisely what we have said all along. But there is much more work to do before the victory lap, most importantly in explaining what happens next.
Well, since it is now common knowledge that it is all about central bank and rigged markets, the next logical step is to predict what happens to markets when looking at “asset prices” from a purely central bank liquidity standpoint, aka the Austrian money flow perspective.
Here, we remind readers that in early 2013, just as the BOJ was preparing to unleash an epic QE episode in order to offset the lost liquidity injections which the Fed’s upcoming taper would lead to, we explained that instead of looking at central banks as standalone entities operating within their own liquidity domains, one has to look at global liquidity as a coordinated whole, one in which every central bank is now an integral cog and where inside money liquidity is not only globally fungible, but transferable from point A to point B at the push of a buy or sell button.
And while for the longest time many, including us, were focused on DM central banks, over the past year a new market participant emerged: Emerging Markets, whose $7 trillion in reserve assets had become a source of reverse liquidity, or “quantitative tightening” as dubbed here over the summer, as numerous nations have been forced to liquidate USD-denominated assets to compensate for the loss of trade exports and oil revenue in the aftermath of the death of the Petrodollar which initially was noticed on this site alone and subsequently everywhere else.
Which brings us to the topic of this post, namely “why are markets all falling down?” and the answer by Citigroup’s iconic, and one of Wall Street’s very best, analyst Matt King who adds that “many investors have been struggling to explain the magnitude and violence of the recent sell-off. Why are EM and commodity price weakness proving such negatives for DM as a whole?”
The answer, hopefully not a surprise to our readers, is as follows:
The violence of the recent sell-off has left many an economist struggling for an explanation. The question is not so much whether oil prices will hit $20, and whether China will have a hard landing. It is why such prospects are having such a profoundly negative effect on developed markets. After all, every economic model says that DM is not particularly exposed to EM, and that lower commodity prices ought in principle to be a net positive for commodity-consuming countries, and at worst neutral for the world as a whole. Does the market know something the economists’ models don’t, or is this an exceptional buying opportunity?
Answering this question has proved hard, in large part because of the potential for circularity. Strategists are basing their market view on what economists tell them about the fundamental outlook. But economists are increasingly anxious that the fundamental outlook is susceptible to the moves in markets.
We think there are three reasons EM and commodity weakness will continue to matter for DM… They suggest that markets have been following global rather than domestic central bank liquidity, and that it may be difficult for them to stabilize without significant further central bank stimulus.
As we have argued for a while, it is not that we are straight bearish, and that these developments can only be resolved in a new crisis. Rather, it is the profound uncertainty, which comes in part from the potential for a regime change, and in part from the circular feedback loops at work in markets, which we have found it so hard to reflect in point forecasts and yet argued should be the central feature of investors’ portfolio positioning. What is concerning at present is that some policymakers still seem in denial about how interlinked everything is.
We hope that after they see the following chart, which shows not only DM net liquidity injections (i.e., q-easing), but also EM net liquidity outflows (i.e., quantitative tightening) and which explains not only the recent selloff, but also shows how to trade global central bank and sovereign wealth fund and reserve manager flows, all confusion and denial will end.
Or perhaps not. As King himself pessimistically concludes, “Perhaps if this sell-off fizzles out by itself, as it did last October, central banks will again be spared the need to face up to the distortive effect they have had upon markets, and can continue the pretence that markets are still following fundamentals. After all, for many of them, this has been the sell-off which ‘isn’t supposed to be happening’.”
We couldn’t have said it better ourselves.
via Zero Hedge http://ift.tt/1nI8igg Tyler Durden