Wednesday, December 21, 2016

This Tightening Cycle Will Hurt

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*We do the math to show that globally central bankers are actually sitting at a minus 27% rate when factoring in bond purchases.

*When inflation starts to tick up central banks will probably react too slowly which will fan inflation higher.

*This ends up being a material medium term risk and probably an important one for 2017.

*We catch the Fed admitting they don't understand the risks of this process.

Let Us Show You Why The Current Global Central Bank Balance Sheet Size Is Equivalent To -27%
There was a Fed study heavily used by Fed Chair Yellen in the summer of this year. We are leaning on that study for this exercise.
This Fed study compared different monetary tools in the Fed's "toolbox." If the Fed had to react to another recession while at near zero interest rates (like they are today) what are their options? One tool was dropping rates by 9%. If they didn't want to go into negative rate territory the research paper said the Fed's other option would be to buy $4T in bonds.
That Fed research links $4T in bond purchases to -9% rates. Either you drop rates at the short end or you force down long end rates by buying $4T in market debt. Both accomplish a similar goal which is to keep rates low to spur on lending and the economy.
Let's now take that relationship and review how big central banks' balance sheets are to determine what is the equivalent rate the world is currently in.
The US balance sheet currently stands at about $4.4T.
The ECB balance sheet currently stands at about $3.7T.
The BOJ balance sheet currently stands at about $3.9T.
Let's add it up. 4.4+3.7+3.9=$12T of global quantitative easing build up.
Using our trusty Fed study formula let's convert that to interest rates. Remember the Fed study compared $4T to a 9% rate cut.
High school level math: If 4T=-9% 12T=X, solve for X.
X=-27%

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