Three Thoughts From London – Choice and Consequence

Three Thoughts From London - Choice and Consequence

  1. When all is said and done, the price action itself has been the main news in these markets.
  2. This is not to say that price action doesn’t matter for policymakers.
  3. It is in the FX market where the price action will probably elicit the most direct reaction, especially EM central banks

1. When all is said and done, the price action itself has been the main news in these markets. What are the consequences of extreme price action? In the middle of all the turbulence, it is often difficult to attribute causality and to think through the wider consequences. The danger, of course, is that market participants are too close to the action and tend to overestimate its importance. There have been several (often desperate) calls for policymakers to react. This has especially been the case for China (PBOC cutting reserve requirements) and the US (delay in Fed hiking). This is a case where the price action may matter less for the reaction function of policymakers than many may assume. For example, the notion of anything like a “Fed/PBOC put” as an actual policy directive seems like a stretch, or just wishful thinking.

2. This is not to say that price action doesn’t matter for policymakers. At the very least, the selloff creates a negative wealth effect, and it can have negative consequences to sentiment in the corporate and financial sector. And at most, it could become a question of financial stability. In fact, there have been several reactions already, especially in Asia. Yesterday, China changed its regulations to allow pension funds to hold as much as 30% in stocks, and it stepped up its enforcement of a ban on selling by large shareholders. Taiwan moved to limit short selling of stocks and ADRs.

3. It is in the FX market where the price action will probably elicit the most direct reaction, especially EM central banks. The concerns are well understood, ranging from inflation pass-through (Brazil and Russia, for example) to corporate borrowing in foreign currency (Turkey, for example). As previously discussed in other publications, a growing number of countries have already stepped up to try to stabilize their currencies – with varying degrees of success. Some of the most recent developments have been: Indonesia following Russia’s lead to pressure exporters to sell some foreign currency. South Korean officials indicated they would “act pre-emptively,” while the Philippines central bank governor said the institution stands ready to inject liquidity into FX markets. And of course, there has been the usual intervention by Asian countries, along with the likes of Peru, Mexico and Brazil to try to smooth price action. In short, don’t let the price action obscure differences.

“And there is escaping things the knowledge of which makes one unhappy. If “truth” is what we know and are aware of, in the most engrossing fiction we escape truth. Whatever else it is, drama is forgetfulness. We can forget and forget that we are forgetting. It is temporary mind control. If memories are pain, fiction is anesthesia.”

– Thomas C. Schelling, Choice and Consequence, 1985.