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Ambrose Evans-Pritchard: If Bernanke really shakes tree, half the world may fall out

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, June 18, 2013

We no longer have a free market. The world's financial asset prices have become a plaything of central banks and the sovereign wealth funds of a few emerging powers.

Julian Callow from Barclays says they are buying $1.8 trillion worth of AAA or safe-haven bonds each year from an available pool of $2 trillion. Nothing like this has been seen before in modern times, if ever.

The Fed, the ECB, the Bank of England, the Bank of Japan, et al., own $10 trillion in bonds. China, the petro-powers, et al., own another $10 trillion. Between them they have locked up $20 trillion, equal to roughly 25 percent of global GDP. They are the market. That is why Fed taper talk has become so neuralgic and why we all watch Chinese regulators for every clue on policy.

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We will find out tomorrow whether Ben Bernanke is ready to blink after the market ructions of the last three weeks, sobered by the cascading upsets across the BRICs and mini-BRICs; or whether he will stay the course with Fed tapering sooner rather than later.

Investors seem to think he will indeed blink, or at least blink enough to put off the day of reckoning for another three-month investment cycle, which is what hedge funds care about, and that if he doesn't blink it will be because the economy is picking up speed. They cling to the Bernanke Put, when the new reality may instead be the Bernanke Call.

Perhaps Bernanke will oblige one more time, knowing that the US economy has yet to absorb the full shock of fiscal tightening, the biggest squeeze for half a century. Besides, core PCE inflation is down to 1.1 percent. Jim Leaviss from M&G says the Fed would normally be cutting rates by 1.5 percent under the Taylor Rule in these circumstances, not tightening.

Yet what causes me to hesitate is the drip of reports and comments from key figures in -- or near -- the Fed seeming to suggest a loss of nerve, or who fear that QE has turned counterproductive.

First we had a paper co-written by Frederic Mishkin -- Bernanke's close friend and a former board member -- warning that is becoming ever-harder for the Fed to extricate itself safely from QE, and the door may shut altogether from 2014.

"Crunch Time: Fiscal Crises and the Role of Monetary Policy" said the Fed's own capital base could be wiped out "several times" once borrowing costs spike. It said trouble could compound at an alarming pace, with yields spiking up to double-digit rates by the late 2020s. By then Fed will be forced to finance spending to avert the greater evil of default.

Then we had the minutes of the Federal Advisor Council arguing that it is "not clear" whether QE is really boosting the economy, while the toxic side-effects are all too clear. It warned of "unsustainable bubbles" in asset prices. It said zero rates are pushing pension funds under water on their liabilities, and even claimed that QE may be causing firms to defer investment.

Since then the Bank for International Settlements has issued a full frontal attack on the credibility of QE, saying it "doesn't work" and is doing more harm than good. Even the Boston Fed's ultra-dove Eric Rosengren has talked of early tapering, a clear sign that the Fed's centre of gravity has shifted.

So don't be surprised if Bernanke talks tough tomorrow, and don't underestimate the implications if he does. The point was put nicely by Jan Loeys from JP Morgan in a note last week:

"In Fed hiking cycles over the past half century, 10-year US Treasury yields on average bottomed some six months before the first rate hike. In the current cycle, where rate cuts have been complemented by large-scale asset purchases, the end of the easy-money period is harder to define. It is surely well before the first rate hike.

"The end of the current easy-money regime is set to have a bigger impact than previous ones as the current one will have lasted much longer and was much more extreme.

"We have learned from past regime changes that the longer they last, the more the market will have got used to them, and could even be said to become leveraged and addicted to the old regime.

"In addition, after major regime changes, we find that the leverage to the old one was each time much larger and in different places than most of us had assumed. A regime change is like shaking a tree and having no idea who or what will fall out."

Brazil, South Africa, and Turkey, are already falling out. Any other candidates?

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