QE: “Questionable Euphoria”?
The Expert View
Featuring Christophe Ollari
Published on: April 1st, 2019 • Duration: 34 minutes • Asset Class: Bonds/Rates/Credit • Topic: Monetary policy, Financial System, MacroDoes QE stand for ‘Quantitative Easing’ or ‘Questionable Euphoria’? Christophe Ollari of Ollari Consulting argues that the economy is currently addicted to central bank intervention and stimulus. Ollari explores recent economic and financial data points, which he links back to a series of bubbles beginning with dotcom spree. Filmed on March 19, 2019 in London.
CHRISTOPHE OLLARI: Which was on Christmas Eve.
My name is Christophe Ollari. I have designed, about something like three years ago, a global macro research MMT asset class and multi currency. I did that after 20 years trading in banks and the hedge fund community.
INTERVIEWER: What triggered the volatility in Q4 2018?
CHRISTOPHE OLLARI: When I came last June, and we already sensed that the prevailing environment was relatively toxic, and we saw some rising fears and threats creeping at the surface. The first one was a nascent trade escalation between the US and China.
Then we had also the synchronous growth downturn and gaining some momentum led by China and Europe with the usual rising concern when we talk about China, which is the hard landing potential, hard landing of the economy. We had, of course, the big, big elephant in the room, which was the Fed, determined to pursue the dual tightening and normalization of the very easy monetary policy, on one side continuing the Fed funds hikes, on the other side, on going on off of the balance sheet.
I think that there was another dynamic, which was very important as well, which was a consequence of the strong dollar, but also of the trade war. Its pressures on the central emerging market central banks to-- that were facing a clear dilemma. It's either supporting the economy, taking the risk to see inflation in their own currency, collapsing with the threat of the capital flight, or just deciding, to some extent, sacrifice the economy in order to support their currency.
This is a choice that most of EM central banks made, Turkey, Argentina, Indonesia, Russia, India decided to hike, which, in fact, contributed to amplify the global tightening of the financial conditions. So that was the main threat in-- when we met so last June. And what has been the rest of the year. It has been, in fact, the confirmation that it was not only a narrative, that it was proper risk.
And everything just shifted into a much more, I would say, Armageddon scenario at the end of September and at the beginning of October. We have three very important dynamics. The first one on the 24th of September, the US administration has applied the $200 billion of tariffs on the Chinese goods. Why it's so important, it's, for the first time, the trade war narrative becomes a reality.
Then you have early October a dual process. First of all, the runoff of the balance sheet of the Fed moves from $40 billion a month to $50 billion a month. And this is happening at the height in September of the FOMC on the 20th of September. And at that meeting, the Fed is already communicating that there will be another hike in December.
Also, early October, you have the ECB, which is having their monthly buybacks from $30 billion to $50 billion and announcing that the end of their monthly buyback will happen early January. What does it mean? It means that early October for the first time since GFC, the monthly flow of the central bank has become negative.
We had a very quick episode early 2015. It didn't last as the ECB [INAUDIBLE]. So you had that dual dynamic, which was extremely disruptive for the market because on one side, the trade war is a reality. On the other side, we can say that the central bank's largest, which has been the trademark of 10-- the past 10 years is over .
Then you have what I call the Minsky moment, which is the 3rd of October. I qualify that as the rookie-share mistake when Jerome Powell, in fact, declares that rates are far from neutral. We know what happened 3rd of October, it's almost the top of all the US equities markets, and it's the peak of oil. It's the peak of the [INAUDIBLE] bonds. And from that point, it has been just a very, very painful quarter and to the end of the year and the postseason, which was on Christmas eve.
INTERVIEWER: What catalyst caused the turnaround in 2019?
CHRISTOPHE OLLARI: In fact, it was very interesting because one of the fear in June as well, it's-- people were already sensing that the Fed was maybe about to do too much and raising the risk of a monetary policy mistake. And I think that the Fed has underestimated the impact of the dual tightening, but, also, we see why the summer was a very misleading period because of the US, the strength of the US equities, the US financial conditions were artificially should very loose.
And, also, because the trade war was just a narrative, in fact, it didn't bite the economy. And, in fact, what we saw, it's manufacturers just frontrunning the tariffs and building up inventories, which artificially give the sense that the economy was still OK. In fact, as soon as the tariffs had been applied, we saw that the economy and China, Europe, and then the US were starting to-- to-- to roll over.
So we-- we went-- so the scenario, the nightmare scenario, ended on Christmas Eve. And, again, we have the dynamic we are talking about with the Fed, with the ECB, with the trade war. But as well, don't forget that people since November were waiting for the Santa Claus rally. And everybody was talking about a positive outcome at G-- under G20 in Buenos Aires. And the Fed in November gave the sense that maybe they were trying to rectify the communication. But then we had the FOMC in December where Powell gave a very hawkish performance.
So poor liquidity, CTA is going out, flushing out all the last of the Mohicans. And then on the 24th of December in what I would describe as a liquidity backroom set off, Armageddon. So we-- we start the year, and we end 2018 in a very sore note. And then early January, you have the first pivot of the Fed, which is completely just reversing the hawkish message of the FOMC in December.
And this is very important because we have learned in 2018 that the Fed is giving the tempo to everyone. So by becoming extremely dovish in January, by shifting its communication, in fact, it forced, to some extent, all the other central banks to lean even more dovish, for one reason, in a current environment of creditors, of deteriorating inflation, and growth outlook, nobody wants a strong currency.
So you add that succession of very dovish comments from starting with the Fed, then the ECB, the RBA, the Bank of Canada. So they all just went for the, you know what, we need to reflate the whole system. Then, of course, we add some positive news on the cut side with determination to at least just stop, pause, de-escalation, but more importantly, maybe to find an agreement and to properly sit at the negotiation table.
The third extremely powerful catalyst was, of course, the multiple announcement from China about new measures in order to reflate the economy, and to kickstart the credit stimulus, and trying to basically kick start the moribund economy. So we had our cuts. We had various measures and new measures like the issuance-- the supply of perpetual bonds against central bank stimulus in order, again, to do what China was doing in the past trying to kick start the credit stimulus.
Also, very importantly, we ended up 2018 with CTAs short, and, especially, of the-- on the Russell 2000, which is not surprising that one of the leaders of the rally in January has been the Russell. And the active community was very-- was basically not positioned for any rally, so very global positioning.
INTERVIEWER: Is this rally questionable euphoria?
CHRISTOPHE OLLARI: So what I found extremely interesting in the rally and in the current dynamic since the beginning of the year, sentiment has-- has just- completely reversed, and it's based on the fact that China will be able to do what they did in the past, which is boosting the credit creation and with the usual ripple effect on the world economy. So successful reflation from China.
On the other side, it's successful negotiation between the US and China. So good for positive outcomes on the trade war. And then a central bank community determine to not only wait, and see, and be patient, but I think, more importantly, already seen as easing further. We are pricing cuts, almost 15 bps in the next 14 months on the Fed side.
For the RBA, we're pricing 25 bps of cuts in the next one year. So it-- this is a very, very powerful mix. It's-- we won't-- we are hoping that reflation would work and be, to some extent, ignore and welcomed by the central banks. And they will even fuel that reflation by cutting. So I think it reminds me, to some extent, what we had in 2009 and 2016.
And this is why I've got some reservations and wondering if that QE Is not all quantitative easing, but is maybe more questionable euphoria. Let's start with one of the dynamics, which is the made-in-China reflation. So as mentioned before, we had multiple announcements about various measures in order to-- to kick start the economy.
The rarity for now, we haven't seen any tangible result. When they did it in 2009, the velocity of M2 had jumped from 15% to 35%. When they did it in 2016, it jumped from 10% to 16%. We are still stuck to the all-time lows of under 8%.
So the question is, is the old transmission model still working or maybe the truth is somewhere else? Are we misled by the real intentions of Beijing? I think we need to keep in mind that the target for Beijing is to move from the old growth model, which was capital accumulation and heavy industrialization to something a bit more balanced, heading towards an economy led by the domestic consumption and export of services.
And I think that the best way to look at it is despite all these measures, [INAUDIBLE] predictions has printed the 17-year low in February and fixed asset investment and that moved and are still stuck to four decades low. Another way to look at it, it's usually in the past when China is pushing on the credit stimulus pedal, the Aussie dollar is sitting waiting.
The Aussie dollar is correlated right now to the [INAUDIBLE] and to fixed-asset investment. It's not believing the [INAUDIBLE]. And this is very interesting. When you put copper, for example, and Aussie dollar, you see the divergence, so who is lying, or who is wrong?
And my guess is the reflation made in China will not lead to necessarily to a big boost of the commodities complex because the nature itself of the growth targeted by China will be less commodities consuming. The bottom line is we are not talking about the ability of China to inflate the economy.
I think the bottom line is, even if they succeed, it's not going to be as deflationary as it was in the past, which has obviously very key consequences. First of all, it's put on the spotlight economies who are very dependent of the growth model from China.
The first one, of course, Australia. Australia was exporting 5% of their goods to China in the early 2000s. Now we are above 30%. And it's highly dependent of the heavy industry, this industrialization, and model of the past.
So what is left to Australia, it's a business model which is not adequate anymore, very leveraged household, falling housing market, domestic banks who are just moving mortgages higher. So it's a very unstable asset. The second casualty that I see, it's Europe as well.
I think that we need very quickly to go back to 2016, '17, '18 because I think that is the crux of the matter. In 2017, everybody praised what we call the revival of the European phoenix. Of course, the improvement of the political scene was important after the elections of Macron. But I think that the reality of the boom, European boom in 2017 is somewhere else.
We can find it in early 2016 when China, and after the Shanghai Accord, decided to go full on-- on the current stimulus. And there is a lag of one year between when China starts to stimulate and the impact on the global economy and with a very important impact on the open economies like Germany.
What happened in 2017? China has completely reverses its approach. The target now is not to inflate the economy. The target is to deleverage the shadow banking system. So, basically, what they did, they just stopped and pushed on the brakes.
2018 downturn in Europe is not caused by the trade war. It's a consequence of the reversal of the monetary policy and fiscal expansion of Beijing early 2017. So you would expect that considering the numerous headwinds in front of the European economy, a less successful reflation made in China would be another major headwind for Europe.
INTERVIEWER: Which economy is the weakest link in Europe?
CHRISTOPHE OLLARI: The other, you know, indicator, which talks to me a lot, is what is another somewhere weakest link in the European area, not in the EU, but the European market? It's Sweden, Sweden, which is extremely dependent as well from Germany.
So it means extremely dependent from the reflation made in China. So Germany, interestingly enough, has become the weakest link, which is quite ironical compared to, you know, the old belief that the weakest link of Europe was-- was the 1,000 countries.
INTERVIEWER: Can the ECB move the needle in Europe?
CHRISTOPHE OLLARI: That brings us to-- to one of the second catalysts for the 2019 euphoria. It's the central bank community would be able to do what they did in the past, which is basically saving the world. Remember what they did in 2008 after the bankruptcy of Lehman?
Remember what they did in 2016 as well because we-- we talk about China, but the Fed opposed the normalization after the first hike in December 2015. The ECB increased. The-- the unorthodox took it, and the BOJ did exactly the same in July with increasing the ETF purchase.
So they've been crucial in the reflation story. Where are we compared to that period? We tend to forget that In 2008, if we put on the side the SNB and the BOJ, most of the official rates were north of 4%. We are far away from the same situation.
The accumulated balance sheet of the Fed, the ECB, and the BOJ in 2008 was $4 trillion and $10 trillion in 2016. We are north of $14 trillion so which means that there is a reality. There is not as many-- most of your cycle back to 2008, but also compared to 2016.
To some extent, this is what we saw at the last meeting of the ECB. It's a question, what can we do? Because, of course, there is no room to normalize because the economy is too weak, and-- and the ECB has one mandate, a central bank, which is inflation, and there is no scope to normalize considering the inflation outlook.
On the other side, where do we go? Do we go further down the rabbit hole of the unorthodox monetary policies and looking like more and more the BOJ? Or do we try to find a quick fix and hope that things will get better?
And this is to-- to some extent, this is the irony of the last set of decisions. The ECB is conscious and aware of the pernicious effects of the negative interest rate policy on the banking profitability, which means, as well, impacting the ability of the banking system to fulfill their most important role, which is providing credit to the real economy.
But what did they do, in fact? They extended the forward-- forward right guidance until 2019, which is more in a-- [INAUDIBLE] for longer, which is counterproductive. But do they have more at their disposal for the time being? I would expect they have. But I think that we will need further deterioration of the macro outlook to see them going that way.
INTERVIEWER: What's your outlook on the dollar?
CHRISTOPHE OLLARI: We saw that, obviously, I don't think that there is any meaningful reflation possible with a strong dollar. And one of the catalysts of the rally at the beginning of the year as well, and I forgot to mention it, is, of course, a five-consecutive [INAUDIBLE] of negative weekly performance of the-- of the US dollar, which-- which was basically another boost to the euphoria, especially in a world where the global liquidity in dollar is still a concern and where, in fact, the debt, denominated in dollars is at an all-time high.
We started the year with a very consensual trade everywhere, the [INAUDIBLE]. And I always mention to my customers, I've got a big issue with that because people who are advocating for dollar weakness forget to tell us what to buy against it. It's not-- it's good, said the dollar, but what-- what is available, especially within the G10?
And for one main reason, it's they still are diverging growth momentum between the US and the-- and the rest. Secondly, any dovish move from the Fed is, to some extent, offset by the need for the rest of the central banks to lean even more dovish. They don't want to appreciate their currencies.
And then you have a currency crisis - You have-- you have rate differentials, which is-- which is another big tailwind for the US dollar. Then a lot of people are talking about do you know the usual US dollar smile, which means that when we are in periods of high uncertainties, the dollar tends to outperform and plays all of a safe haven, which is even more true now because we have a lack of safe haven.
And then the dollar tend to depreciate when we go into that, you know, that sweet spot, where things are a bit better. I think that any improvement of the global situation would take a lot of time, which means that I can't see any big collapse of the dollar in the short term. And I think the best-case scenario would be the shallow depreciation, which will be very limited.
We saw that despite the Fed pivot, the dollar didn't react. Despite the political turmoil in Washington, the dollar didn't-- doesn't react. So I think that there is, for the time being, a structural tailwind for the dollar. And-- and I think that it's-- the consequence as well of the different position of the two, the Fed on one side and the other central banks on the other side, the Fed is the only one who's got a margin of action.
And the rest of the crowd would only react-- if the Fed is dovish, they become more dovish. If the Fed becomes more hawkish, they will just do nothing. So I think the dollar is quite asymmetrical there.