Despite significant cost and hype, monetary policy has not driven growth and clearly driven asset bubbles. The relationship between markets and the real economy is loose at best, however, everyone is willing to overlook real weakness when stock prices are elevated. Any tightening by the US Federal Reserve will invert the US yield curve. The Fed must let inflation expectations increase in the short-run and hope it pulls up the long end of the curve. However, the divergence between the market pricing and the real economy is expected to widen in US and Europe: this gap between cheap capital and corporate earnings creates a dangerous void. If price/earning ratios are too high, a fall can become chaotic. Central banks are driven by fears rather than economic data – this is a policy misstep.
Last week the European Central Bank cut forecasts and announced an additional tranche of TLTROs (bank aid). Normalization was pushed back into 2020 from 2019. Market reaction was unexpectedly sharp, showing the inadequacy of central banks’ defensive measures. Fed commentary suggested that growth has peaked, and a weak payrolls report indicates deceleration.
