🔔 "Central Banks Are Trapped, They've LOST CONTROL"

Depending who you listen to, central banks are TRAPPED, have LOST CONTROL, or are RECKLESSLY OUT OF CONTROL...

We're massively in favour of people understanding more about central banks...

The problem with covering central banks?

They're boring!  

Gotta spice it up a bit with some drama.

So, which is it?

LOST CONTROL, TRAPPED, or RECKLESSLY OUT OF CONTROL...?

Let's answer that question with a question...

Let me explain. They DO have an important role in our economies and society, but we need to take a step back here and regain some perspective.

THEY DON'T CONTROL EVERYTHING

I think this belief that they're some omnipotent deity comes from the association people make between money & power.

If you have money you have power, therefore what could be more powerful than a central bank?

All the money, all the power...

But that's really not how it works.

Central banks tend to have three main objectives:

• Price stability 👇

• Prevent inflation (and deflation)

• Full employment

They set monetary policy to guide markets, step in when required and at extreme times (like Covid), they'll act as a backstop to the system.

They're a lender of last resort when things are going badly, and a release valve when things are going too well (or unsustainably well)...

Market participants take their cues and then embark on their journey of price discovery and central banks largely leave them to it.

Occasionally, if they don't like where markets are heading, they'll intervene by making a speech or comment to guide markets back into line. But they don't usually act.

Other times, the market gives feedback to the central bank.

The RBA 'losing' yield curve control last week is a perfect example of this.

It was no longer defensible, so the central bank stopped defending it.

Traders and the central bank worked together to value the market...

I don't know if this is perfectly accurate (probably isn't) but I like to think of central banks as dumb traders with near unlimited resources.

Not dumb from an intelligence perspective. More of a money-management POV.

Imagine you know a rich trader and you chat markets regularly with him.

Now imagine he's a really wealthy idiot that constantly tells you exactly what he's thinking so that you can front-run him.

Dumb Trader 🗣 : "Hey, if this gets much cheaper I'll be buying loads of it"

Central Banks 🗣 : "If financial conditions tighten further we will extend our QE program"

What's the difference?

Sometimes they'll literally offer free money... 👇

Translated 🗣 : "If you don't buy corporate bonds at these yields, we will"

What happened next?

Traders piled into corporate debt, credit spreads tightened, and companies suddenly had no problem raising capital.

The Fed only had to buy a few billion in the end... The market did all of the work for them.

All because traders believed...

Maybe that's all it takes...

A little bit of faith.

So why do people assign this omnipotent ability to central banks (and governments)?

Maybe the need to believe in higher powers is hard-wired into us...

I think that explains some of it.

It's far more comforting to believe there's a structural order to the world...

What's the alternative?

That the world is highly complex & chaotic?

While we're benefiting from the societal experiments and changes of prior generations, we're just making the rest up as we go along?

Scary stuff!

Too philosophical for a Friday...

While we're at it, for the people that say:

"Everything's in a bubble"

Not according to Howard Marks, who reminds us that assets are valued relative to each other...

And just for fun...

Risitas on the BOE 'misleading' markets...

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