Ok, so what central banks did was, they went out and they decided to see what would happen if everyone (save Haruhiko Kuroda of course who, like his spirit animal Peter Pan, will never concede that he can’t fly) leaned hawkish all at once.
“Maybe the market won’t overreact,” they imagined.
That didn’t work out too well, because as it turns out, a little jawboning was all it took to set off a rates mini-tantrum:
So that’s yields on German, French, UK, and US 10Y government bonds since the hawkish procession in Sintra and obviously, this is a market that is not prepared to absorb a coordinated tightening effort.
What you see in that chart led directly to a rather nasty couple of weeks for systematic/programmatic strategies like CTAs and risk parity and just like that, reflexivity had given central banks a cold, hard slap in the face.
Here’s what Deutsche Bank wrote last week in “The Limit Is Near“:
EU rates have reacted quite strongly, as even such a modest change in language makes a big difference in a world where investors have become accustomed to central bankers finding reasons to maintain stimulative policies. This episode provides a good example of just how difficult the eventual path to policy normalization is going to be.
The biggest risk on that path to normalization is a correlated unwind of monetary stimulus, or the exact opposite of the correlated wave of liquidity we witnessed since the financial crisis hit in 2008.
For the time being, we think the central banks are not going to be able to go too far on their paths to normalization.
“Take a minute to let that sink in: the limit is near on policy normalization and they haven’t even started normalizing yet,” we marveled.
This was the state of affairs that led directly to Janet Yellen leaning dovish in her testimony on Capitol Hill and this is also the dynamic that paradoxically makes lackluster inflation prints like what we got in the US last week and what we got in the UK on Tuesday good news for central banks – it gives them an excuse to walk back an experiment in hawkishness gone horribly awry.
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