Central Banks and long term trends

Following the global markets is an interesting exercise. There are events and data points which are happening across the seven seas and each one impacts the other. Even if they don’t one can surely come up with a narrative which will justify every move. Also, the urge to attribute a cause to every movement is very high. Markets move up as “inflation fear subsides”, markets move down as “taper fear inches up”. The possibility that individual markets can move up or down in a small range even without any corresponding cause is invariably lost on the commentator fraternity. We ourselves regularly add to the din with amazing regularity.

The fact that small movements should not be attributed any causality don’t absolve us from identifying long term trends. Trends can exist on multiple time scales. The world has moved from a multi polar set up to a uni polar structure, centralised planning has given way to decentralised decision making, the world has become highly financialised and no corner of the globe is aloof from a hot money supply chain. All these and many more are monumental changes which not only impact how the markets operate but also define how asset prices evolve across time and space.

All the above matters would probably require a complete book to explain and understand hence we would restrict ourselves to more immediate and proximate concerns. That is the role of central banks and a centralised authority in current global markets. This matter is of immediate interest as we will have the MPC policy meeting in India later this week. Various asset markets will take cue on how accommodative the RBI vows to remain, whether they increase the facility under various targeted lending schemes (LTRO, TLTRO) and whether some announcement on form and features of GSAP 2.0 will be done. Readers would note that among all this manufactured demand and supply, the on-ground conditions like the onset of a monsoon, spread of the virus, state of jobs take a backseat.

Something which is true domestically is happening at a much larger scale at the global level where Fed’s purchase of 120 bn USD worth of treasury and MBS are impacting the markets across. Let’s see it with a very small example, if Fed buys MBS regularly from the banks which are making these loans then they get cash released for making more loans. There is a finite stock of residential property (assume for one minute that the MBS are backed by residential mortgages only) hence the urge to make more loans in that market will do two things, property prices of the existing stock would rise and the credit standards to onboard new customers (read borrowers would drop). Consequently, the LTV value would drop because the rise in property prices is not due to some fundamental reason but the Fed’s policy to buy the MBS. Suddenly these securities are not that safe anymore. Any reader which starts seeing the phenomenon as a 2008 redux is not entirely wrong.

Also, any excess cash pumped into the banks in developed markets will ultimately find its way to the EMs. Not only EMs, this money flow eventually finds its way to all the other conceivable assets too. The recent surge in commodity prices from lumber to copper is one example. Brent Crude is now trading around 70$/bbl which is its highest level in two years. Explanations like improved an outlook on mobility and supply restrictions can then follow to suit the mood of the day. Fed’s FOMC is scheduled for mid-June, the policy will be very keenly watched for three points; one whether they taper (unlikely), whether they talk of taper (likely) or finally they talk about the talk of taper (very likely). Markets from Antarctica to Mongolia will reconfigure accordingly.