Bank of America: “These Are The 4 Things That Can Pop The Central Bank Bubble”

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It’s a new year… and just like last year, we greet it with not only record highs across equity markets, but a new rip tighter in spreads: as shown below, on Thursday the Barclays corporate index spread hit just +90 bps the tightest since Feb ’07.

And, as BofA’s Barnaby Martin writes in an overnight note, what should be clear already is that this credit cycle won’t simply roll over and die of old age. “Far from it, we think. In fact, we believe one underappreciated risk by the market in 2018 is that Euro credit spreads get squeezed to eye-wateringly tight levels, spurred on by a still-supportive central bank backdrop.”

Yet what makes the ongoing grind all the more confusing is that all major central banks are either in the process of hiking rates, shrinking balance sheets and QE, or at the very least signalling the limits to their monetary policy.

What’s going on?

According to Barnaby, “the current backdrop feels very reminiscent of the Greenspan era of 2004-2006. Back then US interest rates rose 17 times. Yet, financial conditions remained loose and interest rate volatility fell to very low levels precisely because Fed monetary tightening was so predictable and patient: rates generally rose by 25bp at each meeting.”

And, as discussed here previously, fast forwarding to today reveals that the same backdrop has taken hold: namely that despite hawkish overtones by central banks, financial conditions have again been loosening over the last year (Chart 1).

But have central bankers truly learned nothing from the previous two bubbles? Well, according to BofA, burnt by successive market tantrums, central banks have learned to plead for the market’s patience as they exit their extraordinary policies. For now, this “gentleman’s agreement” between markets and central banks is keeping rate volatility near record lows, even if yields themselves are moving higher.

But what, if anything can pop the central bank bubble?

That, according to BofA – and everyone else who watches the daily market meltup in stunned silence – is the question: “Absent a recession what is most likely to end the central bank induced bull market for risk assets?”

According to Martin, it would clearly need to be an outbreak of more hawkish – and less predictable – central banks. Specifically, greater rate volatility is what would ultimately break the great reach for yield trade. Here, the strategist believes that there are four things that could provoke a …read more

Source:: Zerohedge.com

      

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