JAMIE MCGEEVER: The $64-billion question - Are we in a bubble?
'With credit still so cheap and easily available, growth so strong, and volatility and inflation so low, why wouldn’t you load up on risky assets like stocks?'
A decade on from the financial crisis, global monetary policy is finally tightening, with the Federal Reserve raising U.S. interest rates and other central banks gradually turning off the stimulus taps.
But despite the “normalisation” underway, there’s a glaring abnormality that should be flashing red to the Fed and central bankers everywhere: financial conditions are easier now than at any point in over 40 years.
From an investor’s perspective, though, the flashing light is green, not red. With credit still so cheap and easily available, growth so strong, and volatility and inflation so low, why wouldn’t you load up on risky assets like stocks?
The Chicago Fed’s national financial conditions index was last at -0.94, its lowest since April 1976. The Goldman Sachs U.S. financial conditions index is now at its lowest level since January 1990, when it was first compiled.
Both indices are widely-used benchmark measures of U.S. - and by proxy, global - financial conditions.
“U.S. financial conditions are now as supportive of growth as they ever have been,” Goldman analysts wrote in a note on Thursday.
This is the mirror image of soaring markets like equities that a growing number of observers say are now starting to look like bubbles. Indeed, equity prices form part of Goldman’s FCI index, along with other variables such as the value of the dollar, the slope of the yield curve and credit spreads.
Wall Street just had its best January in over 20 years, setting a string of fresh highs in the process and registering its longest stretch ever without a 5 percent pullback. Investors are pouring record amounts into global equity funds too.
Until fairly recently, bond yields were the lowest in history. They’re still pretty low - trillions of dollars worth of sovereign bonds in developed economies still boast negative yields.
“There are two bubbles: We have a stock market bubble, and we have a bond market bubble,” former Federal Reserve chairman Alan Greenspan told Bloomberg TV on Wednesday.
The trouble in the bond market “will eventually be the critical issue,” Greenspan said, adding that “for the short term it’s not too bad.”
Greenspan is famously accused of stoking the U.S. housing bubble that burst in 2007 and nearly took the global banking system and economy down with it the following year.
Central banks and governments were forced to act. With trillions of dollars, euros, pounds and yen of support, they prevented financial and economic catastrophe from becoming annihilation. Just.
Nobody seriously suggests a repeat of 2007-08 is on the cards. But the plunge in Goldman’s financial conditions index and surge across many markets should, at the very least, be on central bankers’ radar.
Central banks will no doubt act again if and when financial bubbles burst. But because the economic backdrop and banking system are more robust now than at any point post-crisis, they may not act quite so quickly or aggressively.
In the words of a portfolio manager at one of the world’s biggest asset managers: “The safety net is there, but they’ve lowered it.”
What’s more, policymakers’ ability and capacity to mop up the mess this time around are more limited. Interest rates are still near record lows, central bank balance sheets are bloated, and governments remain loaded with huge debts accrued from the last crisis.
With financial conditions this loose, investors will continue to buy. And central bankers will continue to hope their exuberance remains rational.