THE WORLD’S central bankers could be forgiven for thinking that things are never going to get back to normal. More than six years after the financial crisis plunged the world into recession, monetary policy looks nothing like it did before those events.
Even as economists predict that the US Federal Reserve and Bank of England (BOE) will finally begin to raise benchmark rates next year, the central banks are unlikely to push borrowing costs anywhere near pre-crisis, inflation-fighting levels. And even though the Fed in October ended the bond-buying campaign it undertook when the US economy was weaker, it isn’t shedding the assets it bought. The European Central Bank (ECB) and Bank of Japan (BOJ), for their part, are stepping up purchases.
Independent thinking
Central bankers know that global growth is shaky, that debt is rising and that they’re getting little help from government fiscal policies, Bloomberg Markets magazine will report in its January issue. Economic progress will again depend on the monetary spigot in the coming year – as will stock prices, bond yields, commodities demand and currency rates.
“Given the slow and unsteady nature of the recovery, supportive policy remains necessary,” Fed chairwoman Janet Yellen said in November at a conference of central bankers in Paris. Monetary officials should keep trying extraordinary measures, Yellen argued, especially because fiscal policy today remains “somewhat contractionary”.
In the US, more government spending to stimulate growth isn’t on the cards, especially after Republicans won full control of the US Congress in November’s election. In the euro zone, governments can back away from austerity only slightly before they run up against EU rules and German opposition. In Japan, Prime Minister Shinzo Abe’s fiscal stimulus plan has been blunted by a consumption tax increase that went into effect in April.
The International Monetary Fund in October forecast that the global economy would expand 3.8 percent in 2015, up from an estimated 3.3 percent for 2014, but below the boom years of 2004 to 2007, when growth was 4.9 percent or higher.
While the US economy is accelerating, the euro zone is slowing, with growth there vanishing in the third quarter. China has slowed. Japan has slipped into recession again, contracting two quarters in a row, which has prompted Abe to postpone a second scheduled tax increase and call snap elections. Monetary policymakers are scrambling to provide support to a still fragile global economy.
“To be a central banker is an impossible task,” Thomas Mayer, the former chief economist at Deutsche Bank, said. He compares the actions of central bankers since 2008 to that of US generals in the Iraq War: They started with shock and awe and won the initial battles, but they ran into trouble when it came time to withdraw.
The difficulty of getting out after six years of mostly co-ordinated global monetary stimulus was evident in stock markets recently. The MSCI world index lost about 9 percent in September and the first half of October, before gaining almost all of it back over the next six weeks. No single reason can explain such a swing, but investors attributed the sell-off to concern that global growth is slowing, that deflation is a threat – and that, this time, monetary policy responses are exhausted.
The Fed has been trying to gradually wean investors and the economy off of quantitative easing, tapering its asset purchases from $85 billion (R938bn at yesterday’s rate) a month in 2013 to $15bn in October 2014.
New support
At a meeting in October, Yellen ended the bond-buying programme. By then, stocks were rebounding. The Fed’s move did not interrupt the momentum, and right away, stocks got new support from central bankers elsewhere.
BOJ governor Haruhiko Kuroda and his policy board said in October that they would boost asset purchases to an annual pace of about ¥80 trillion (R7 trillion).
ECB president Mario Draghi announced in November that his institution stood ready to make more purchases and expand its balance sheet. He followed that up with a speech later that month in which he said the ECB should return inflation to target levels “without delay”.
The divergence in monetary policy, with more stimulus for Japan and the euro area and less for the US and UK, is likely to push the dollar and sterling higher.
Foreign exchange strategists surveyed by Bloomberg predict that the euro will weaken to $1.20 in the second half of 2015 from about $1.25 recently. The yen has fallen 7.7 percent to about ¥118 to the dollar since the announcement of more BOJ bond buying. The median forecast is for a drop to ¥122 by the end of 2015, while the most bearish prediction has the currency plunging to ¥135 to the dollar.
A currency war of sorts may be brewing, in which officials in Europe and Japan try to weaken the euro and the yen to help them avoid deflation.
“Though there is no explicit agreement by representatives of the Group of Seven to drive the dollar higher, much of the world now agrees the US currency should appreciate,” Stephen Jen, the co-founder of London-based hedge-fund firm SLJ Macro Partners, said.
With weak growth in major economies, central banks – including the Fed and the BOE – were likely to remain relatively dovish in the near future, Gustavo Reis, a global economist at Bank of America, said. “They’re going to be very sensitive to what’s happening to the economy and act conditionally on the data,” he says.
Bank economists surveyed by Bloomberg expect 2015 will be the year in which the Fed raises its benchmark federal funds rate after six years near zero, with the first increase coming in the second half. They predict that BOE governor Mark Carney and his colleagues will start raising rates sometime after a general election in May. But these moves are likely to be modest – and may yet be delayed.
Past mistakes
The thinking of monetary authorities today was coloured by the mistakes of the past, Lars Svensson, a former board member of Sweden’s Riksbank, said. The Fed, for example, boosted rates in 1937, choking off a recovery in the US and prolonging the Great Depression. In a more recent misstep, the ECB hiked rates half a percentage point in 2011, even as the euro zone sovereign debt crisis undermined growth and employment.
Svensson quit the Riksbank policy board in 2013 after objecting to its overly tight monetary stance. The Swedish central bankers raised rates in 2010 and 2011, concerned about rising household debt and home prices, and then were forced to reverse. They’ve cut rates seven times in the past three years, and the bank’s benchmark reached zero in October.
A major reason for interest rates to stay low next year is the likelihood that inflation will remain tame worldwide, even if prices don’t fall enough to spark deflation. Economists at Morgan Stanley say price increases are running below central bank targets in virtually all developed markets. They predict the Fed will not raise its benchmark in 2015 and that the BOE will wait for the final quarter to do so.
“Low inflation is the new enemy as it harms debtors, reduces the scope for negative real interest rates and damages central bank credibility,” Joachim Fels, Morgan Stanley’s chief international economist, said this week.
A dovish bent in global monetary policy, however necessary, means savers who want their money in low-risk investments such as bonds or bank deposits will continue to get paltry payouts.
Central bank efforts to keep borrowing costs low punish those who need to build retirement nest eggs, according to Larry Fink, the chief executive of BlackRock, the world’s largest money manager, who spoke at the same Paris conference as Yellen.
A survey of financial professionals, meanwhile, shows concern about the potential for rising rates to send fixed income investments into a dive. In the Bloomberg Global Poll of November, traders, investors and bankers identified government debt and high-yield corporate bonds as the asset classes they would most likely sell short, preferring them over real estate, stocks and even gold as a place to bet on a rout.
There’s another reason for central bankers to go slow on rate hikes: The world is swimming in debt.
The level of debt in the global economy, excluding financial companies, is up by more than a third since 2008, according to a September report by the International Centre for Monetary and Banking Studies in Geneva. The report concludes that the potential global growth rate has dropped to less than 3 percent from about 4.5 percent prior to 2008.
The more debt there is, the greater the cost to governments, businesses and consumers of higher rates – and that translates into a worse drag on growth.
Balance sheets
Central bank balance sheets are not going back to normal any more than rates are. After three rounds of quantitative easing in the US, the Fed held a record $4.5 trillion of assets on its balance sheet at the end of October, up from less than $1 trillion in 2007.
The US central bank and the BOE have said they will not start selling the securities they have acquired until after they begin raising rates. The BOJ and ECB, of course, are still adding assets.
Multitrillion-dollar balance sheets show that central banks had entered a new, more interventionist era, Ben Friedman, a Harvard University economics professor, said. In the past these institutions left more of the power to set prices in the hands of markets, but the change made sense.
Friedman said: “They should be prepared to use the asset side of the balance sheet symmetrically, so sometimes it will be appropriate to buy assets and other times it will be appropriate to sell assets.”
Buying assets
In the euro zone, where inflation is running less than a quarter of the ECB target of just below 2 percent, it’s time to buy more assets. The central bank’s balance sheet peaked at e3.1 trillion (R42.6 trillion) in 2012 and then shrank as banks paid back emergency loans, dipping below e2 trillion in September.
The November 6 announcement signalled that the ECB was headed back toward e3 trillion in assets and might soon buy sovereign debt in addition to the private securities it had purchased. Moving to make such purchases risks a fight with German officials, who argue that they may violate the ECB’s founding treaties and object that they will reduce pressure on governments to overhaul their economies.
Central banks are giving direct support to bond prices worldwide and are indirectly boosting equities because safer fixed income assets pay so little.
Stock markets had become reliant on monetary support, says Matt King, the global head of credit strategy at Citigroup, said. He estimates that central banks need to pump about $200bn into the global economy every quarter to keep stocks from falling – and that no net monetary stimulus will cause a 10 percent quarterly drop.
As central bankers search for the right levers to promote growth, it’s all for naught unless they prevent the credit excesses and overhyped markets that threw the financial system into turmoil in 2007 and 2008.
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Central banks will… be putting weight on financial stability issues or risks when making their decisions,” Bank of Canada governor Stephen Poloz said. “Central banks were first invented for what we’d now call financial stability reasons.
“We’ve come full circle. We’re back to our roots.” – Bloomberg