Citi: "We Are Becoming Convinced That The System Won’t Stabilize" – How Central Banks Broke The Market
By Tyler Durden
After taking a three month leave of absence, Citi’s Matt King has stormed right back to the front lines of financial reporting where his original perspective is very critically needed, and following up on his latest must read presentation which we posted two weeks ago and dubbed “the tipping point“, overnight Citi’s chief credit strategist is out with a new note titled “The race to the bottom”, which focuses on the negative feedback loop world in which “liquidity breeds liquidity and illiquidity breeds illiquidity” (we are now in the latter phase), and how this impacts both global markets and the global economy, and how central banks are desperately struggling to prevent it all from crashing down.
In this note we will layout King’s thoughts on the market; his observations on the economy will be presented at a later time.
From Citi’s Matt King
The race to the bottom
No, we’re not talking about currency wars, though they do illustrate the phenomenon. Nor are we thinking about € credit spreads and yields rapidly converging on (and in some cases surpassing) the zero bound.
Rather, a significant theme of our research in recent years has been the tendency of investors to assume they live in a zero-sum world, only to face a rude awakening when they discover that markets think otherwise.
Think of the reaction to falling (and now rising) oil prices, for example. What ought just to be a redistribution of wealth between oil producers and oil consumers has turned out not to be. Both markets and the global economy have proved an awful lot happier when prices have been rising than when they have been falling.
The same applies in multiple other spheres. We talk about money flowing from one market to another as though there is a fixed amount of it. Yet we have argued elsewhere that it is constantly being created through credit expansion in the private sector and on central bank balance sheets, or destroyed through deleveraging and defaults, and that changes in the multipliers – as opposed to the flows themselves – are at least as important as a driver of market movements and economic growth.
On multiple fronts we fear that what was a positive-sum game previously is now turning negative, and that the potential for some recent trends to run and run is still underappreciated, with potentially far-reaching repercussions.
Liquidity breeds liquidity; illiquidity breeds illiquidity
Take market liquidity, for example. Despite near-record notional volumes on TRACE, and policymakers’ protestations that nothing has really changed, market participants continue to lament that bid-offer is misleading, and depth is not what it used to be. Worse, many managers have struggled to make money on the basis of traditional single-name fundamentals, and poor performance is contributing to a steady leakage of flows away from traditional benchmarked funds towards totalreturn funds, indices and ETFs. The shift is not unique to credit: in European equities, futures-to-cash ratios – one convenient measure of index trading versus single-name trading – have reached all-time …read more
