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10 25 2015 | by Victor Xing | Capital Markets

What are examples of policy-induced financial distortion?

QE and prolonged policy accommodations have led to financial distortion.  Loose monetary policy have cemented the view that monetary policies outweigh economic fundamentals, and that the focus should be on the second derivative of any event: how would it affect policymakers’ projections and economic outlook?

  1. Bad is good, and terrible is excellent.  It is not uncommon to see stocks rally when more people are out of work or soft wage growth persists.  Bad data is akin to the Bat-Signal.Crime happened – summon the Batman.  If bad data happened, dovish FED communications will likely materialize.  In the mean time, long stocks, oil, HY, EM bonds, short dollar, and wait for the powerful savior to respond.
    Financial distortion is akin to a city that cannot fight crime without external intervention
    Financial distortion is akin to a city that cannot fight crime without external intervention
  2. Pricing signal distortion.  In the case of the European Central Bank, short maturity Germany sovereign bonds can still exhibit “upside surprise” in price if they yield more than -0.20%, the floor of ECB QE purchase limit.  -0.20% is merely an arbitrary limit set by the the bank.  If it is changed to -0.25%, front-end of the Bunds curve can easily go to -0.25%
  3. Heavier emphasis on market flows.  QE purchases (at least initially) punish value investors and reward momentum traders.  Buying because central bank is buying become an accepted investment thesis at various points during FED and ECB’s easing programs.

Next article10 23 2015 | by Victor Xing | Economics

Why has disinflation prevailed despite money-printing?