(Bloomberg Markets) – In Hong Kong, crypto trader Sam Bankman-Fried stole a nap on his office beanbag to get through 18-hour days as the demand for digital assets soared. At an auction in Wellington, Darryl Harper declared the New Zealand real estate market “wild” when he lowered the hammer on homes hundreds of thousands of dollars above their official valuations. In Makati City, Philippines, AC Energy Corp. CFO and Treasurer Corazon Dizon was overwhelmed by an appetite for a $ 300 million green bond. And in Midtown Manhattan, hedge fund manager David Einhorn was amazed at an application from a 13-year-old who claimed he had quadrupled his money.
A common thread runs through these scenes from the plague year 2020: cheap money fed in by the world’s most important central banks has inflated assets and reshaped the way we save, invest and spend. And that’s not all. Unlike previous rallies, where investors had no clarity on when monetary taps should be tightened, this time officials have explicitly stated that they will stick to their loose guidelines well after a Covid rebound.
The strategy is clear and deliberate: wipe out the volatility from the bond market and make debt the cheapest ever to prevent saving and encourage investment. The Hope: Cheap cash drives companies to invest and hire as rising asset prices make people more confident and willing to spend. The inevitable side effect: more volatility for assets (other than bonds) when investors pursue returns around the world. And of course the risk: inflated asset prices will burst and undermine financial stability before the real economy can benefit from all the money.
“It cannot be overlooked that if you drastically increase liquidity, money is looking for returns and can certainly expose assets to mispricing,” says Agustín Carstens, General Manager of the Basel, Switzerland-based Bank for International Settlements . Called Bank for Central Banks. “This is a risk and something that needs to be recognized and monitored very, very carefully.”
Signs of bubbles can be seen everywhere as stock prices have risen by an amount not seen since the dotcom era, new stock listings have boomed, and Bitcoin, although volatile, continues its generally soaring spike. However, if corporate earnings fall below expectations or if the vaccine rollout falters, risk markets will teeter as investors take money off the table.
Central bankers, starting with Jerome Powell of the US Federal Reserve, are aware of the danger. Soaring valuations – what some investors are calling an “all rally” – were too obvious to ignore. Powell, the Governor of the Bank of Japan, Haruhiko Kuroda, and other leading central bankers have downplayed the concerns despite being held accountable for market bubbles in recent months. This is partly because they are aware of the danger of closing the money spigot too quickly. After the last crisis a decade ago, policymakers in some economies were likely too quick to withdraw incentive for fear of bubbles forming and eventually slowed economic recovery.
When the spread of the pandemic stalled across much of the world, most central banks went all-in. They lowered positive interest rates to close to zero. Where interest rates were already razor-thin, they massively increased asset purchases. Many have set up emergency funding for businesses in trouble. and this time most promised to maintain their unprecedented attitudes for years to come. In 2020, according to the International Monetary Fund, governments introduced tax incentives of at least $ 12 trillion and central banks made trillions more available.
It worked. Global bond markets, which showed alarming signs of relocation last March, became calm. The stock markets recovered. Emerging market currencies have strengthened and central banks have also embraced the easing. The result has been extraordinarily low returns, even for longest-dated debt securities and traditionally riskier borrowers.
As of December 31, $ 17.8 trillion in debt was trading with negative returns. Governments from Australia to Spain have been effectively paid for loans. Junk bonds in the US traded for yields similar to investment-grade corporate bonds that were rated just two years earlier. When Peru sold its first 100-year bond in November, the instrument became the lowest-yielding security of its term ever issued by the government of a developing economy.
“The central banks, and especially the Fed, have already created bubbles,” says Alicia García-Herrero, chief economist in the Asia-Pacific region at Natixis SA in Hong Kong, who previously worked for the IMF and the European Central Bank. It points to the separation between booming markets and a very uneven economic recovery. “Central banks know what they’re doing – they’re basically lowering the returns on safe assets in order to increase the demand for risky assets. Once you do, you know a bubble may appear, but the cost of doing nothing is likely even higher. “
When the November auction of seven homes in Wellington was met with fierce tenders, a modest 80-square-meter three-bedroom cottage cost NZ $ 945,000 (US $ 678,000) – well above the government’s prorated $ 640,000 government estimate of NZ $ 640,000. “Historically, interest rates have never been lower,” says auctioneer Harper. “This makes it easy for buyers to borrow.”
While New Zealand’s central bank managed to sidestep the global financial crisis without resorting to quantitative easing, the pandemic blew it up. The Reserve Bank of New Zealand cut interest rates and launched a bond purchase program, the effects of which, combined with a supply shortage, shed light on property prices in the country. Given the deep cost of borrowing that fueled home demand, the government urged the RBNZ to consider the property market when setting its policy – a move the bank resisted.
Harriette McClelland and Harry Greenwood, both in their late twenties, were bidding for their first home and missed it when the price approached NZ $ 1.2 million. “I am disappointed,” said McClelland at the time. Blaming some of the lack of lack of supply, she added, “But obviously, low interest rates really escalated things a lot.”
This disappointment is being reflected worldwide as inequality between different population groups deepens. Owners who value assets see a sharp increase in wealth, while those who do not own assets miss them.
The world’s 500 richest people increased their total net worth by $ 1.8 trillion to $ 7.6 trillion in the past year, according to the Bloomberg Billionaires Index. Through January, Amazon.com Inc. founder Jeff Bezos remained the richest person in the world thanks to the growing craze for online trading during the lockdown. Then, in what is possibly the fastest phase of wealth creation in history, Elon Musk jumped to first place after Tesla Inc. appreciated in value. Together, these two men made roughly $ 217 billion in 12 months, enough to send $ 2,000 checks to more than 100 million Americans.
Critics say central bankers are deepening inequality by driving markets to foamy heights while doing little to boost wages or create jobs in the real economy. On the other hand, there is the argument that, ultimately, monetary policy has limited ability to heal a ruined economy. Reserve Bank of Australia Governor Philip Lowe admitted this to Canberra lawmakers in December: “I can only try to make the aggregate strong,” he said.
Instead, more government spending is needed, according to former US Treasury Secretary Lawrence Summers and former Chairman of the Council of Economic Advisers Jason Furman. Democratic lawmakers have urged the Fed to revive initiatives it launched to help smaller businesses and communities. For its part, Republican lawmakers have sought to restrict the Fed’s ability to use non-traditional policy tools. In late 2020, they forced the exit from five emergency credit facilities, sparking further political battles, especially if asset price inflation persists. Joe Biden’s administration will have the opportunity to help shape the debate if he appoints appointments on the Fed Board.
There is no doubt that massive injections of cash have made it easier for financially troubled governments to finance budget deficits. They kill bond vigilantes, those investors who want higher returns, especially for longer-term securities, when a government’s borrowing increases to offset the added risk of repayment. Today central banks – explicitly in the case of Japan and Australia or implicitly in the case of the US and some others – are even dampening long-term returns with guidelines that ensure continued easy money.
Fed chairman Powell alluded to momentum in a press conference on December 16 when he commented on soaring US stocks and their increased price-earnings ratios. “Granted, PEs are high,” he said. “But that may not be as relevant in a world where we believe the 10-year treasury will be lower than it was in the past from a yield perspective.” He spoke after the Fed tied its balance sheet expansion to making progress towards its inflation and employment targets – a marked move from spring 2020 as it aimed to avert a lockdown-induced credit crunch.
For Paul Nolte, portfolio manager at Kingsview Asset Management LLC in Chicago, Fed policies were the key driver in his decisions last year. When it became clear last spring that monetary policy was riding to the rescue, he said it was “a moment of ‘Ah, here comes the Fed'”. Starting in April, after monetary authorities began pumping liquidity into the markets, it stocked up on high-yield bonds as well as investment-grade credit and stocks.
During the summer, he received calls from customers who were alarmed at growing concerns about a coronavirus resurgence given his bullish market positioning. “Some of them called and said,” It’s too risky, we have to buy cash, “says Nolte.” They couldn’t understand what was keeping the stock market going. I would tell them, “The key to this is the Fed. You want to pay attention to the economy, but you need to pay more attention to the Fed.” Later in the year, he still preferred riskier assets, turning to sectors like small-cap stocks and emerging markets too.
On the same day in December that Powell made his stimulus pledge, Bitcoin topped $ 20,000 for the first time on its way to a 305% gain in 2020. Scott Minerd of Guggenheim Investments told Bloomberg TV that the amount to be settled The current value of the world’s largest cryptocurrency is still a long way off. The Fed’s scarcity and “rampant money pressures” suggested that Bitcoin would eventually climb to around $ 400,000, though Minerd tempered his excitement in January after Bitcoin fell 21% in a matter of days, saying, “Bitcoin is parabolic The increase is not sustainable in the short term. “
While established crypto traders remain the main force behind Bitcoin, newcomers to the digital market, including large corporations and Wall Street investors, also play a role, says Hong Kong-based Bankman-Fried, who founded and also founded the FTX derivatives exchange the crypto runs trading firm Alameda Research. “The low interest rate environment means that more and more companies are saying,” Let’s put our money in Bitcoin, “he says.” I work 17 or 18 hours a day and take a nap when I can in the office. All of our metrics are high above. “
Bubbles are not an economic problem until they burst. Efficient markets should calculate in the future so the rally in stocks, property prices, bonds and Bitcoin could signal robust expansion as the global economy shakes off the coronavirus shock. “The greatest risk is that capital market central banks will stop behaving badly,” said Michael Shaoul, CEO of Marketfield Asset Management LLC. The central banks’ medium-term promise to weaken the tightening had “already been priced into many financial decisions.”
For example, private equity and other non-public investors have invested in commercial real estate despite the pandemic raising questions about the future of cities. Commercial real estate rebounded despite exposure to shopping malls, restaurants, hotels, and offices that could generate lower long-term revenue in a post-Covid world. BBB-rated commercial real estate bond premiums in the US almost halved between May and the end of 2020, according to Bloomberg. This is despite the default rates on commercial mortgage-backed securities, which Goldman Sachs Group Inc. said did not improve as of November. For placement-linked securities, the default rate was nearly 23% and for retail it was 12%, according to a Goldman report in mid-December.
As investors pursue returns wherever they can find them, the rising tide of cash also flows into bonds sold by companies in poorer economies. This is the case even in countries hardest hit by the pandemic. When AC Energy, part of the Philippine conglomerate Ayala Corp., sold a $ 300 million perpetual green bond at 5.1% in November, CFO Dizon described the demand as “overwhelming”. The optimism of the vaccine, as well as expectations of a strong rebound in 2021, helped pave the way for AC Energy fundraising. “In the morning we announced the mandate and in the evening we set the prices,” she says. “It usually takes two days. But we saw that the market is very strong, so our bankers recommended that we just close everything during the day. “
For all the market optimism that was abundant at the start of the new year, one thing was clear: the global economy will need a strong recovery to justify high valuations in global equity markets.
In October, soaring stocks convinced Einhorn’s Greenlight Capital to bet against a so-called “bubble basket of mostly secondary companies and recent notable-valued IPOs”. For those who believe that the central bank’s incentive is a solid foundation for betting, Einhorn shows that the history of monetary policy in Japan and Europe shows that “artificially controlled long-term interest rates are no justification for stratospheric stock valuations”.
The surge in stocks since the darkest days of the financial system in late March last year – a spike that saw the S&P 500 index jump 68% from its lowest point this month to year-end – also let companies take advantage of the flattering valuations. The IPO grossed around $ 180 billion on the U.S. stock exchanges in 2020, more than double the previous year’s figure and well above the previous high of $ 102 billion in 2000, according to data compiled by Bloomberg. These included some blockbuster debuts like Airbnb Inc., which more than doubled 113% on the first day of trading, and DoorDash Inc., which was up 86%.
The IPO wave was also driven by a new investment structure that involved so-called special purpose vehicles, which have become increasingly popular in recent years. SPACs raise money through public offerings and use the funds to buy shares in target companies, which they identify after their listing on the stock exchange.
Until recently, these companies have focused on “sectors of value” where assets are seen as undervalued. Then came 2020. According to Goldman analysts led by David Kostin in a December report, not only did a record number of SPACs hit the market, but 31% of them didn’t even specify an industry they were targeting. The total revenue has increased more than fivefold. From early July to mid-December, the market saw an average of more than one SPAC IPO per day. “Given the Fed’s commitment to keep policy rates close to zero, we expect SPAC activities to continue at a rapid pace in 2021,” the report said.
For all the effects – from central banks to government bonds to stocks, real estate and emerging markets – the most worrying dynamic for many is the explosion of new public and private debt. Borrowing increased by $ 15 trillion in the first three quarters of 2020 to a record high of more than $ 272 trillion, according to the Institute of International Finance. The Washington-based group warns that emerging market debt without banks is rapidly approaching 210% of gross domestic product, up from 185% in 2019 and 140% a decade ago. The fear is that falling income will make it harder to repay this debt, even with low interest rates.
If inflation rises and central banks are forced to resort to easing, bond markets around the world will feel the pain and possibly even fail a recovery. The 2013 Taper Tantrum is illustrative. When then Fed chairman Ben Bernanke announced a future reduction in his quantitative easing program, US Treasury bond yields rose and markets around the world rose. This time the exit will be even more dangerous given the larger range of stimuli.
Even if things work as planned, there are risks. Japan is an example of the kind of challenges that arise when monetary policy stays in place for a long time. Japanese investors have been effectively pushed out of their country’s government bond market by the Bank of Japan’s insatiable QE, destabilizing institutions that have traditionally relied on park investments in these securities, particularly regional banks.
Yoshihide Suga’s government is working with the BOJ to streamline the entire regional banking industry and prevent potentially disruptive collapses in the years to come. Other major investors, including the huge savings scheme running out of post offices, have turned to investing overseas, leaving them vulnerable as the yen appreciates foreign assets and makes them less valuable domestically.
Another weakness, highlighted by Japan’s years of experimentation with ultra-light monetary attitudes, is that quantitative easing has undermined longer-term productivity by propping up businesses that were likely to have failed. This is the case when governments and corporations can borrow so cheaply that there is no incentive to make structural adjustments that cause short-term pain such as job loss.
“Central banks [in advanced economies] are in a global liquidity trap, ”says Jerome Jean Haegeli, Chief Economist at the Swiss Re Institute in Zurich. “The liquidity bazooka buys time and drives up asset prices, but it has no value in improving economic trend growth. Like a black hole, once in, it’s extremely difficult to get out. There we are in the central bank business and in a black liquidity hole. “
The time for maximum upward movement – if policymakers do their utmost to stimulate their economies – could be drawing to a close and a tougher period on the horizon, says Richard Yetsenga, chief economist of Australia & New in Melbourne Zealand Banking Group Ltd. “While the risk profile for growth has decreased,” he says, “it will soon increase for asset prices and financial stability.” – With Matthew Brockett, Katherine Burton, Elena Popina, Tassia Sipahutar, and Cecilia Yap
Anstey is a senior editor in Boston and Curran is the chief correspondent for the Asian economy in Hong Kong.
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