Article / 19 July 2016 at 9:30 GMT

Markets should be careful what they wish for

Head of FX Strategy / Saxo Bank
  • Brexit vote spurs markets to life on widespread easing hopes
  • 'The risk of a global melt-up could pick up from here'
  • Japanese stimulus may be fully priced in to yen crosses

Helicopter money
Helicopter money may be the next item in central bankers' collective tool box, 
but it brings its own array of difficulties. Photo: iStock 

By John J Hardy

We’re less than a month from the shock Brexit vote and apart from the large drop in the sterling exchange rate, the trauma this event inflicted on global markets has now been entirely erased. 

One might even argue, in fact, that the Brexit vote has actually helped global markets to rally, as investors are convinced that global central banks will err on the side of dovish caution to prevent any economic contagion from Brexit. 

The Bank of England is likely to launch some form of quantitative easing in August to complement a lifting of former chancellor Osborne’s fiscal austerity. Elsewhere, central banks were already seen as turning more accommodative lately with the US Federal Reserve clearly on hold for now to assess whether the US economic recovery is faltering and Japan about to launch large-scale fiscal stimulus after growth stumbled amid a steeply appreciating Japanese yen. 

And China, the world’s most significant source of growth for the last 15 years, is clearly determined to maintain a level of stimulus for now to keep the economic activity humming, even as it continues to inflate a fearsome and unsustainable debt bubble.

It’s an odd state of affairs and should remind us of the market regime back in the 2010-11 time frame, when every negative US economic data release was almost celebrated for its implications for US dollar liquidity from the Fed as USD liquidity was feeding global risk appetite and an emerging market bubble. And we should be even more afraid than usual of the central banks’ policy intentions if central banks now allow a melt-up in risk appetite. 

The risk of a global melt-up could pick up from here if the EU makes a strong political commitment to bailing out Italy’s too-big-to-fail banks. Indeed, a risk appetite melt-up amidst weak economic fundamentals would catch central banks off guard with the sudden realisation that they have been playing with matches and gasoline. 

The market’s dance with central bank policy will then reach a dangerous new phase: take away the fuel and markets collapse; keep providing it and things burn out of control. Economic fundamentals, you ask? Not really part of the equation...

Specifically, markets are celebrating the much-anticipated next phase of central bank and now fiscal policy: so-called “helicopter money”, a somewhat loose term that covers everything from increasing fiscal expenditures that are then covered by extra central bank bond purchases, to outright cash injections into consumers’ pockets, the truest form of helicopter money. 

Real helicopter money would indeed begin to address the growing inequality problem, as cash in the hand would be felt the quickest and the most by society’s least well-off. For now, Japan appears reluctant to shift all the way to full helicopter money and is likely to attempt BoJ-covered stimulus first. Therefore, the yen may not weaken much further now as the market’s expectations may have run ahead of where Japanese policy is ready to go.

But markets should be careful what they wish for. Sure, helicopter money is a much more powerful and direct tool for stimulating the economy than quantitative easing and especially zero and negative interest rates. But unlike QE, it is also truly inflationary, particularly outright cash drops. 

These are tools that central banks, and increasingly governments, will inevitably reach for to stave off weak growth and the spectre of deflation. Inflation is the only policy imperative in a world drowning in debt. That’s because inflation is the only way, without mass defaults, to reduce the relative burden of so much debt. 

But one person’s debt is another person’s savings. In other words, we’re about to see a lot of paper wealth destroyed in real terms. And fiat currency exchange rates will be at the centre of the race to the bottom.

Hanging by a thread
And it's a long way down. Photo: iStock 

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

20 July
Jim Earls Jim Earls
Or we have a hyper deflationary wipe out of this credit bubble and the JPY and USD soar in value.


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