Morgan Stanley: Central Banks Are Injecting $100 Billion Per Month To Crush Vol And Spike Markets December 11, 2019
One week ago, in response to the recurring question whether the Fed’s latest direct intervention in capital markets is QE or is NOT QE, we answered by looking directly at how the market itself was responding to the Fed’s liquidity injections.
The answer was clear enough: just like during the POMO days of QE1, QE2, Operation Twist, and QE3, stocks have risen in every single week when the Fed’s balance sheet increased, following the three weeks of declines that led to the October 11 announcement. What about the one week when the Fed’s balance sheet shrank? That was the only week in the past two months since the launch of “NOT QE” when the S&P dropped.
And yet, some doubts still remains.
As Morgan Stanley’s Michal Wilson writes today in his Weekly Warm Up piece, “in recent marketing meetings, several clients have asked if we think theFed’s $60B/month balance sheet expansion is QE or not.” In response, Wilson gives the podium to MS interest rates strategist Matt Hornbach who says that it’s “Q” but not “QE.” In other words, “there is little debate that the Fed is increasing the quantity of money, or Q. However, they are not taking duration out of the market so the additional money lacks a direct transmission mechanism to the equity markets or other long duration risk assets.”
While semantically Wilson and Hornbach are correct, the outcome is obvious: whether it is Q, QE, or NOT QE, the money is clearly making its way to the market when the Fed’s balance sheet expands, and vice versa.
And quite a bit of money it is, because it’s not just the Fed.
As Wilson further elaborates, “we continue to see the 3 largest central banks in the world expand their balance sheets at the rate of $100B per month ($60B from the Fed, $25B from the ECB and $15B from the BOJ).” As a reminder, several years ago, Citi’s fixed income guru Matt King said that it takes $200 billion in quarterly liquidity injections across all central banks to prevent a market crash, and lo and behold we are now well above that bogey.
But wait, there’s more: in case $300 billion per quarter was not enough, last week there was also an announcement that Japan would enact a new fiscal stimulus of approximately $120 billion which could be as much as $230 billion when you include the private economy incentives. That, as Wilson puts it, “is a lot of money.” It’s also an issue for the traditionally bearish Wilson, who as a reminder in mid November got a tap on the shoulder and, kicking and screaming, was “urged” to raise his S&P bull case target to 3,250.
It could go even higher.
As Wilson notes on Monday, “as part of our year ahead outlook published a few weeks ago, we cited this excessive liquidity as a reason why we thought the S&P 500 could trade well above our bull case year end target of 3250 while this policy action persists. As of right now, it appears that the Fed, ECB and BOJ will continue at this pace through the first quarter of next year.”
But wait, didn’t Wilson just say moments earlier that the liquidity injection by central banks “lacks a direct transmission mechanism to the equity markets?” Well, yes and no. Wilson connects the two, by explaining that in his view, “the central bank transmission mechanism is via suppressed volatility”, to wit:
The recent actions by the Fed were intended to reduce volatility in the repo market but it’s also had the effect of reducing the volatility in risk markets. Exhibit 1 and Exhibit 2 show 30 day realized volatility for the S&P 500 for two periods. The first period is the post crisis financial repression era, and the second is the longer term. As you can see, we recently reached one of the lowest readings of this era when we hit 5.7% at the end of last month after a brief spike in September when repo markets became disrupted.
To put this in context, this reading is in the first percentile of the past 7 years, a time when QE and financial repression has been very active…
Click for Full Text!