Macquarie: Central Bank Interest Rate Repression Creates “Slaves”
While central bank interest rate policy has been a relatively muted factor in stock market performance recently – successive rate hikes and hawkish Fed inclinations have mostly been warmly greeted by stock market advances – this pattern is about to change, predicts a July 18 Macquarie research report.
Central bank quantitative interest rate repression, known euphemistically as “stimulus,” has created a mirage of tranquility that is visible, in part, through historically low stock market volatility amid a mostly volatile geopolitical and national situation.
The situation cannot be reversed and will result in a situation where “slaves remain slaves.”
Quantitative interest rate repression: QE stimulus is a two-edged sword that has yet to show its real downside
The latest central bank machinations must be understood in context in order to map probability paths going forward.
The 2008 financial crisis has forced the US Federal Reserve into a corner of sorts, as unprecedented measures were required to engineer a recovery. The Fed resorted to “aggressive” quantitative easing and zero if not negative interest rates, the report stated, pointing to a negative in the title: “Rights, Wrongs & Returns; CBs – can slaves become masters?”
What is documented to have occurred following this bending of economics textbooks to a never before witnessed state, resulted in impacts both positive and negative.
The odd gymnastics were part of a financial engineering experience that was documented to have been followed by a rise in asset prices, particularly stocks, which supported consumption and inflation, measured in part by high-end real estate and rare art. During this period general wages remained stagnant and commodities consumed by all demographics haven’t shown significant signs of life.
While central bank stimulus achieved a goal with a certain target audience, Macquarie notes they “had massive costs.” These costs can be seen in popular society.
Central bank policies “aggravated inequalities,” supported “zombies” which in a free market society would have been put out of business. The impact on core market supply and demand dynamics has yet to be fully felt, as the central bank activity “diverted funds towards speculative uses and depressed already low productivity.”
While these have been tangible relative to the past, it is the future that is perhaps most important.
Quantitative interest rate repression: Economy entering “treacherous” period
The previous decade benchmarked by quantitative stimulus had bolstered an odd dependency on debt that has resulted in “a palpable feeling” that change is on the way. Macquarie thinks central banks, with little dry powder left at a time when the economy is “entering one of the more treacherous periods since 2013,” is attempting to regain some control “and be free from the slavery of a ‘financial cloud’ of their own making.”
While quantitative easing has resulted in economic positives, the market dependency it has created and the expansion of the Fed balance sheet to historic levels puts the central bank on a tightrope while juggling 200-pound weights in each arm that seem to get heavier all the time.
The depths to which quantitative stimulus have damaged free markets, including a price discovery function that Macquarie says central banks are looking to “resurrect,” is currently unknown.
Typically, free markets serve a moderating function in an economy. When too much debt or unchained fiscal excess has been promulgated by a government, bond yields rise, acting as a “governor” to slow debt expansion.
In a centrally managed economy where quantitative interest rate repression takes place, such limits on fiscal excess are not held in check by the bond market, as rates remain low regardless of debt levels or fiscal responsibility. This has led to an odd feedback loop.
Quantitative interest rate repression: Central bank policies have turned them into “slaves” of their own making
Macquarie notes that central banks, as a result of quantitative interest rate repression, are currently engaging in a containment phase, one that is just shy of deleveraging.
This situation, along with other global forces colliding, may be too little too late, as “normalization is no longer possible.”
“Price discovery is incompatible with the need for ongoing financialization of economies dependent on assets for growth,” the report said.
Without specifically stating it, the authors were saying the free market economic system upon which the most significant wealth in the history of the world has been built is changing core performance drivers.
There are no options. “Hence slaves must remain slaves.”