No, not a reference to the impending season of culinary excess but rather, as Wikipedia would describe it:
‘the abrupt cessation of substance dependence and the resulting unpleasant experience’.
What am I on about? I’m on about the continuing and seemingly endless uncertainty over the future direction of the US and by extension global interest rates… for these are indeed unusual times. Our global economy appears to be addicted to a monetary drug. These are the most extraordinary monetary conditions in not just generations, but centuries.
Where to start? How about Italy? In a piece of news that will surprise anyone with even a limited interest in the bond markets, Italy has, in the week, sold debt at a negative yield. Investors are effectively paying the Italian government, which has one of the highest debt-to-GDP ratios in the developed world, to look after their money for them. Someone is on a trip for sure.
What this does show is that Mario Draghi and his ‘big bazooka’ (his programme of quantitative easing, for the avoidance of doubt), are having an effect. Never before have we seen such a prolonged period of monetary easing and yet the global economy is still struggling to escape the after-effects of the Great Recession. Even in the US, after years of growth, falling unemployment and rising asset prices the Fed still feels compelled to keep rates nailed to the floor at 0.25 per cent. Last week the FOMC (the USA’s version of our own Monetary Policy Committee), led by Janet Yellen, voted 9-1 to keep rates at the same level they have been at for seven years now, to the surprise of… absolutely nobody. Remember MySpace? The last time the Fed raised rates, Facebook had 1/10th the number of users of the long-forgotten social network.
Why are we stuck at zero and why is there is so much interest in what happens next? The reason is fear. Fear of what happens when we finally try to free ourselves of this addiction. Cold turkey is an unpleasant experience remember. Back to Wikipedia:
‘The supposed disadvantage (of cold turkey) is the unbearable withdrawal symptoms which may cause tremendous stress on the heart and blood vessels (and in a worst-case scenario, death).’
The problem for the Fed is that justifying a move now is tough. Take your pick for reasons to stay on hold. Inflation is invisible, unemployment is indeed low but so is the labour participation rate, suggesting many people are available to work but have just ‘dropped out’. Wages are stagnant, the emerging markets are submerging, markets panic at the slightest thought that their dose is going to be restricted and crucially, there is scant expectation of a rise.
Still, investors have already focused their attention on the committee’s next meeting in December, where there are murmurs that the Fed may, at long last, try to get the economy standing on its own two feet again by hiking rates. Easier said than done. William Lee, Citigroup’s chief US economist, has suggested that the Fed seems stuck in a feedback loop, whereby its decisions cause market upheaval, which in turn affect its decisions, and so on. Why are investors so sensitive? Simple: leverage
The many trillions of pounds that have been pumped into the world economy by central banks have made it incredibly easy to borrow large amounts of money at a very low cost. Claudio Borio, chief economist of the Bank for International Settlements, estimates that combined public and private debt now stands at 265 per cent of GDP in developed economies. This does not even include 'unobservable debt' such as derivatives. It becomes clear why markets are spooked by almost anything. They have become hooked on the powerful monetary narcotics administered by doctors Yellen, Draghi, Carney et al.
So, what will the withdrawal symptoms be once the patient is unhooked from the intravenous drip? Who knows? It is likely we will see an awful lot of tumult in the weeks after a Fed rate rise. But the bigger issue is what central banks will do if another crisis hits and they have no monetary ammunition. There are other options but we stray even further into uncharted territory. As our private equity readers know, a great company is not a good investment without a convincing exit strategy. It would seem, in this case, that the world’s central bankers are sorely lacking one.
So what’s our view? Well, there are risks to the global expansion and if another recession does strike it seems clear our monetary authorities are running out of conventional ammunition and fiscal policy remains constrained by austerity economics. Taking some time to consider a plan B would be time well spent. As for interest rates, we think the anticipation is worse than the reality (a bit like the dentist). Provided it is well flagged we think they should get on with and start the process. The reality is no-one is planning cold turkey. Monetary withdrawal will be slow and gradual under most scenarios…the sooner we start the better.
The longer we binge, the worse the hangover will be!