When star stands for confusion

r-star down, return on capital up
  • Recent statements are a reminder of the importance of neutral rates for policymakers
  • But they also illustrate confusion – not only about the level of r*, but even as to what it is supposed to be measuring
  • At the heart of the confusion lies a failure to distinguish between the impact of balance sheet on markets, and of rates on the economy
  • This potentially leads to very different conclusions for r* and policy

Seven lessons from complexity

Under conventional economics, volatility shouldn't form clusters - but it does
  • Markets and economies should be analyzed as ‘complex systems’
  • Their fat tails and emergent behaviours fit poorly with traditional linear economics, but very well with complexity modelling techniques
  • Lessons from other complex arenas apply equally well to investing

Short-term exuberance alert

trailing 12m cb liquidity down, equities up
  • We have been arguing markets face greater risk of melt-up than melt-down
  • But the speed and extent to which many levels are deviating, not only from fundamentals but even from many technicals, is striking
  • Expect fund inflows to continue to swamp such concerns – but watch for any sign of faltering

The asymmetric Fed

cash assets at small and large us banks still far from 2019 lows
  • The significance of last week’s FOMC lies neither with the rate view, nor with the earlier, larger taper of QT – mildly bullish though both of these are.
  • It comes instead from the stark asymmetry of the response function which was described.
  • While the true test remains with the details of the liquidity outlook, in conjunction with the Treasury refunding this opens the door to a continued cross-asset rally through Q2.

Free replay clip: Why are financial conditions so benign?

- Markets seem abnormally exuberant - It's not just the stronger economy - It's the impact of easy money
  • Free clip from first ten minutes of 2 May webinar
  • The exuberance in risk assets is less a consequence of a stronger economy than a driver of it
  • The expectation of rate easing was never critical – which is why the exuberance has largely persisted even as yields have backed up
  • It is instead the direct consequence of investor crowding following easy central bank balance sheet policy – and vulnerable to any reduction in CB liquidity

Replay: Why are financial conditions so benign?

- Markets seem abnormally exuberant - It's not just the stronger economy - It's the impact of easy money
  • Full replay of 2 May webinar with Q&A
  • The exuberance in risk assets is less a consequence of a stronger economy than a driver of it
  • The expectation of rate easing was never critical – which is why the exuberance has largely persisted even as yields have backed up
  • It is instead the direct consequence of investor crowding following easy central bank balance sheet policy – and vulnerable to any reduction in CB liquidity
  • Open to clients with Group Webinar or One-on-One subscriptions, and to the press

Cliff notes on credit

ccc-b spread differential ratio to hy index spreads at record highs
  • Relative CCC cliff risk has risen to record highs
  • This partly reflects hidden idiosyncratic risks from low recoveries and abandoned covenants
  • But mostly it signifies the macro suppression of index spreads

Why are financial conditions so benign?

presentation cover page
  • Financial conditions have eased to the same levels as 2007
  • This comes in spite of central banks thinking they are running restrictive policy
  • The nature and timing of the market moves suggest these not so much reflect or anticipate the strength of the economy as drive it
  • Their ultimate cause is easy balance sheet policy having crowded investors into risk
  • Misunderstanding of these dynamics increases the likelihood of bubbles and subsequent busts

When crowding stops, markets drop

fund flows vs cb liquidity
  • The $280bn weekly drop in Fed reserves is the largest since Apr22
  • Just as then, it coincides with a correction in markets
  • A drop in fund inflows seems likely to follow
  • But this still feels more like seasonal correction than decisive turn

Why are financial conditions so benign?

presentation cover page
  • Financial conditions have eased to the same levels as 2007
  • This comes in spite of central banks thinking they are running restrictive policy
  • The nature and timing of the market moves suggest these not so much reflect or anticipate the strength of the economy as drive it
  • Their ultimate cause is easy balance sheet policy having crowded investors into risk
  • Misunderstanding of these dynamics increases the likelihood of bubbles and subsequent busts
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