Banks Begin To Mutiny Against The Fed: "If We Are Right, Central Banks Will Be Wrong"

It has been a trying time for the world's central bankers, who for decades have been used to the "high finance" community's adulation, derived from the deliverance of policy wrapped in so much opacity, gibberish and contradictions, that neither the central bankers, nor the markets, had any idea what was going on (see the Greenspan tenure), or dared to admit it was all meaningless drivel, resulting in phases during which the market was on "autopilot" and culminating with a bubble and subsequent crash, "rescued" by an even greater asset bubble and even greater crash, etc.

However, after generations of largely uncontested and unquestioned monetary policy where only the occasional "tinfoil" fringe blog dared to say that central banker emperors are not only naked and clueless but are also the cause of the world's biggest problems, more and more voices are emerging to both challenge the prevailing monetary religious dogma, as well as daring to do something unprecedented: tell the truth.

One example was Bank of America's chief strategist, Michael Harnett, who on Friday confirmed what we had been saying for years, that "central banks have exacerbated inequality via Wall St inflation & Main St deflation" and that the Fed failed in its mission to make the poor richer, instead its destructive policies have made the top 1% wealthier beyond its wildest dreams, and have been directly responsible for such political outcomes as "Brexit" and "Trump."

 

Then there was the WSJ, which on the front page, led with a headline that would have been anathema for "established" (i.e. sycophantic) financial journalism as recently as a few years ago:

"Are Central Bankers Twisted Geniuses Or Bumbling Ex-Academics" the WSJ blasted on its front page, with James Mackintosh writing the following:

Are central bankers twisted geniuses manipulating the markets in order to meet their inflation goals?Or are they bumbling ex-academics whose ramblings are overinterpreted by investors besotted with their brilliance?

After last week's "communication" debacle, and as a result of the unprecedented ongoing collapse in the yield curve and plunge in inflation expectations at a time when central banks are coordinatively hawkish resulting in ever more deflationary market outcomes, increasingly more observers have become convinced that "bumbling academics" is the correct answer.

Which brings us to the latest note by Deutsche Bank's Dominic Konstam, who dares to go so far as to stake his team's credibility in "fighting the Fed"saying that "If we are right, then [central banks] will be wrong" and adds that "we are biased towards a view that central bankers are not as powerful as they think they are in terms of delivering to their economic ‘targets'. Structural forces are more important."

And so, the sellside mutiny against the Fed has officially begun, nearly nine years after we first said that the Fed's response to the financial crisis was the biggest financial mistake in the Fed's 100+ years of existence. Of course, DB's phrasing is somewhat more contained - for now - but the moment has come and gone: the Fed "emperor", in this case Yellen, has been called out for being naked and this nobody can afford to ignore it any longer.

Below we present some of the key highlights from Konstam's latest note, "Fumbling in the Dark?" which we are confident will be copied and immitated in the coming days, and may, in retrospect, have the same impact on the prevailing religious dogma involving monetary policy as Martin Luther's 95 theses.

There is every possibility that global central banks have a good handle on the pulse of the global economy and know what they are doing. There is also every possibility that they don’t.The key will lie in the  adjustment process for risk assets, particularly equities as well as the data. And as we demonstrate below precisely because of the manner in which risk assets have performed since 2013, investors should not be complacent.

We think the apparent shift towards a more hawkish policy stance from the likes of Draghi as well as some of the smaller central banks needs to be viewed in terms of the complexity surrounding the Fed’s own normalization process. Inflation has disappointed and curve resteepening from last summer with a rise in inflation expectations has been reversed to various degrees. The fear is that all else equal more may follow. We think this is more about talking up the outlook than having any exceptional insight into the future.

 

 

We have been arguing the Fed (but also some other central banks) have bemoaned the flattening and shifting lower of the Phillips curve but remain hopeful that it will reverse. The “explanation” partly lies in the hope that there are non linearities in the relationship and wage inflation can suddenly kick up and/ or NAIRU may be being mis-estimated and so once we find NAIRU, the Phillips curve will “recover”. Equally important is a central bank self-justification that inflation targeting reinforces the Phillips curve. As the ECB has recently argued the existence of the Phillips curve relationship makes central bank policy easier in that it allows for a closer control of inflation outcomes implying less output gap sacrifices. Inflation expectations can be rapidly brought under control, when inflation is rising too much; and on the downside, falling inflation expectations can be pre-emptively stabilized allowing for more effective monetary policy through avoiding the classic liquidity trap (real rates are allowed to fall). The  fact that the central banks have had a poor record in reaching their inflation target is therefore of great concern in that it maybe undermining the Phillips curve. Therefore emphasizing that inflation is alive and well, perhaps even threatening to raise the inflation target as the IMF has suggested is a rationale reaction to the evidence