Once the power to manage expectations has been lost, the central bank bag of tricks is empty.
No one knows precisely how and when the global unraveling will impact
their corner of the planet, but we do know one thing with absolute
certainty: central banks are out of tricks.
Like all good conjurers, the major central banks will claim that their
magical powers to inflate asset valuations and inspire the animal spirits of
risk, borrowing and spending are unimpaired, but this time the audience
knows the truth: their magic is threadbare and their trick-bag is
empty.
Obfuscation and doublespeak are primary components of central bank magic.The
magic is largely semantic: if the Federal Reserve claims it can restore
the economy and the stock market with reverse repos and other financial
legerdemain, the corporate media is always ready to repeat this dubious
claim until it is accepted as self-evident.
The central bank magic is fundamentally a mind-trick of managing expectations. If
the Fed (or other central bank) announces a quantitative easing or
market-goosing program, punters buy assets anticipating the success of
the bank's program, effectively creating the very push higher the bank
intended.
This rise draws in other traders, and the program is declared a success
as the market generates a self-reinforcing logic: the market's response
is evidence the central bank's program is a success, which then inspires
more risk-on buying and further market gains.
Once a central bank program fails to generate a self-reinforcing rally, the mind-trick's power is broken. Once
expectations of a sustained rally are crushed by the failure of the
rally to achieve virtuous-cycle lift-off, the magic no longer works:
once traders take a wait and see stance rather than rush to place
panic-buy orders, the initial rally soon fizzles, and the expectations
of effortless gain are replaced by gnawing fear of more losses.
Once expectations revert to caution, the central banks lose their power to move markets with pronouncements. Unfortunately
for believers in the omnipotence of central banks, monetary legerdemain
has little power over the real economy. Once the power to manage
expectations has been lost, the central bank bag of tricks is empty.