As Greece faces another default and global markets are mounting a unified "freak out" session, the fact that China's PBOC (Peoples Bank of China) cut rates over the weekend and markets sold off in Asia on Monday, is not getting as much attention as one would anticipate (or maybe that is the real reason markets are selling off and Greece is just a cover story). The ominous inference is that if a rate cut does not have a desired effect of boosting markets, what will? And more ominous, broadly speaking, is the concern over whether central bank stimulus has lost its impact on affecting markets.Concerted Central Bank Easing
Like good soldiers falling in line, the world's central banks, one after the other, have participated in one of the most orchestrated global stimulus efforts in history. The fact that each central bank seems to have taken its turn at easing is too coincidental to think it was not a concerted effort by governments to stagger their efforts to get a prolonged effect from additional stimulus. This is not to say that there was absolutely no overlap in stimulus programs from different countries but the manner in which the US and Japan followed by the EU announced and implemented their plans appears very coordinated. With global rates at, near or in some cases below zero, new forms of stimulus are required. With the US, Japan and finally the EU implementing their own forms of quantitative easing (QE) that form of stimulus seems to be off the table as an option unless central banks can artfully form a different variety that markets have not seen yet. With governements venturing in to uncharted financial territory they may wonder, why not keep going? Once you've left the reservation what boundaries are you constrained by?
Zero Return World
As central banks have globally reduced interest rates to zero, capital has staged a massive hunt for yield, any yield. The equity markets and junk bond markets have been major beneficiaries of this hunt for yield. Real estate has made its own comeback, as well. Market strategists have justified higher multiples on equities as equivalent returns on corporate debt have declined. In an extreme scenario, corporate debt would yield 1.0% and stock multiples would correspondingly rise to near 100, resulting in near zero asset returns with little to no consideration of risk. In essence, central banks are responsible for creating this environment through their stimulus programs and their unintended consequences. Proponents claim that the recession was not worse because of the Fed's efforts, but that is a lazy defense that cannot be proven or disproven. The most notable impact of stimulus has been its impact on asset prices. The economic recovery has been uneven and on-going for over 7 years. Markets are a discounting mechanism so it is natural that they improve ahead of the data but to date that relationship is out of whack. In this case, the data is way behind the market's performance and is still huffing and puffing to catch up. The result: very low returns across all asset classes. The real barometer of the economy: commodities. Old gauges of a healthy economy, oil demand and copper demand, have declined. Market participants have conveniently disregarded these old markets indicators.
The Proverbial String
Outside of China, central banks cannot force their constituents to borrow, buy and invest. This is the conundrum that the US and the other developed economies face. The labor market has improved but wages are stagnant. Auto sales have stages a huge comeback but it looks like that cycle is about to end with another generation of buyers stuck in extended subprime auto loans sucking up any available consumer discretionary income. This is with interest rates at zero. If things deteriorate from here, what levers does the Fed have? There are no rate cuts left. How does the Fed encourage consumers to borrow going forward? Regulations have left the financial industry hindered and US corporations are more interested in investing in their own stock than to implement capital expenditures plans that would normally create organic economic growth. As these corporations issue debt for financial engineering, the cash remaining on the balance sheets will be needed to retire this debt as rates inevitably rise, eliminating any option for capex spending. This seems to leave the Fed in the precarious position of pushing on a string when and if it needs to battle the next inevitable financial crisis.
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