Central Banks

There has been a significant weakening in China’s exchange rate in recent days. Although the spot rate against the dollar has moved by only about 1.3 per cent, this is actually a large move by the standards of this managed exchange rate. Furthermore, the move is in the opposite direction to the strengthening trend seen in the exchange rate over the past three years.

This has triggered some pain among investors holding long renminbi “carry” trades, along with much debate in the foreign exchange market about what the Chinese authorities are planning to do next. Since China does not explain its internal or external monetary policy in a transparent manner that is intelligible to outsiders, there is much scope for misunderstanding its true intentions. The key question is whether the Chinese authorities are changing their commitment to a strong exchange rate and, if so, why? Read more

The leading central banks in the developed economies have, of course, been the main actors underpinning the global bull market in risk assets since 2009. For long periods their stance has been unequivocally dovish as they have deliberately tried to strengthen an anaemic global economic recovery by boosting asset prices.

In the past week, we have had major statements of intent from Janet Yellen, the new US Federal Reserve chairwoman; from the European Central Bank; and from the Bank of England. After multiple hours of fuzzy guidance about forward guidance, the clarity of previous years about the global policy stance has become much more murky. Central banks are no longer as obviously friendly to risk assets as they once were – but they have not become outright enemies, and they are unlikely to do so while they are concerned that price and wage inflation will remain too low for a protracted period.

It is now quite difficult to generalise about what central bankers think. However, a few of the necessary pieces of the jigsaw puzzle slotted into place in the past week. Read more

Ben Bernanke’s tenure as Federal Reserve chairman ends this week. Financial Times markets and investment columnist John Authers speaks to Gavyn Davies, principal of Fulcrum Asset Management, who analyses the massive expansion of the Fed’s balance sheet under Mr Bernanke, and the course he has set for his successor, Janet Yellen

The generally optimistic tone at Davos last week was rudely interrupted by a melt-down in emerging markets, triggered by concerns that the major central banks in the developed economies are contemplating an exit from easy money sooner than previously expected.

The Fed will probably take its second step towards tapering next Wednesday and now seems to be on auto-pilot for the rest of the year. More surprisingly, the Bank of Japan sounded some cautious notes about the likelihood of further quantitative easing when fiscal policy tightens in April. Finally, the UK authorities, in the shape of “aides of the Chancellor”, hinted that a rise in short rates may be no bad thing this year.

A significant shift towards tighter monetary policy in the developed world as a whole still seems extremely unlikely, given the deflation risks highlighted by the IMF last week.

But the British case is now very intriguing and, after contradictory messages at Davos, also somewhat confused.

Because of low productivity, the level of UK GDP continues to lag well behind the recovery from the Great Recession achieved in many other economies. But the remarkable recent surge in UK growth rates, along with a sharp fall in unemployment, means that the Bank of England now has to reconsider its entire monetary stance. With forward guidance now in murky waters, the markets will want greater clarity in the next Inflation Report in February. Read more

Janet Yellen is likely to be confirmed by the Senate as the next Fed Chair on Monday, and Ben Bernanke delivered an initial version of his own personal history in an address to the American Economic Association on Friday.

Typically objective and analytic, it won him a standing ovation (watch it here [1]) that accurately reflects what the majority of the academic economics profession thinks of the man and the public servant. Despite the highly controversial nature of his actions, they view him as one of their own. He has risen to greater importance in public office than any previous member of the academic economics profession, including John Maynard Keynes.

The history books will no doubt focus on the Fed’s role in the great upheavals of the age. The outline verdict is already clear for some of this.

The Fed clearly underestimated the impact of the housing bubble on the economy, and failed in its regulatory duties from 2006-08; its reaction to the financial panic in 2008-09 was exemplary; its role in cleaning up the US banking system in 2009 was important and far-sighted; and its balance sheet expansion from 2010-13 was more aggressive than most other central banks, with both good and also some not-so-good effects. (See this blog for a lengthy assessment of QE.)

According to the “great person” view of history, Mr Bernanke will be the individual who gets most of the blame and plaudits for all these developments. The buck stopped on his desk. Yet he was only one actor among dozens in Washington. As a believer in the “great events” view of history, I have been trying to identify the areas in which Ben Bernanke personally made a difference that others might not have made. Read more

As we enter 2014, the five-year bull market in developed market equities remains in full swing. Recently, I argued that equities now look overvalued, but not egregiously so, and that the future of the bull market could depend on when the level of global GDP started to bump up against supply side constraints, forcing a genuine tightening in global monetary conditions.

Today, this blog offers a year end assessment of three crucial issues that relate to this: the supply side in the US; China’s attempt to control its credit bubble; and the ECB’s belief that there is no deflation threat in the euro area. At least one of these questions is likely to be the defining macro issue of 2014 and beyond. Read more

In recent months, inflation has again reared its head as a problem in the developed economies. But this is not because it is too high. In most countries, headline CPI inflation has been falling significantly since the end of 2011, and it has now dropped to less than 1 per cent in both the US and the euro area.

Furthermore, the pervasive decline in headline inflation has been accompanied by a similar decline in core inflation rates, which are also hovering at worryingly low levels in most countries. In fact, out of the 25 developed economies that publish regular data on Haver Analytics, only Iceland is currently experiencing an inflation rate that could be considered markedly too high by any of these measures. Read more

Mark Carney’s announcements today about the UK housing market represent the first blast from a major country of a new policy weapon that is increasingly available to the global central banks, a weapon known as macro prudential regulation. Because this weapon is seen as an alternative to raising short rates, not as a prelude to raising them, the Carney intervention should logically under-pin the lower-for-longer path for short rates discussed in his evidence to the Treasury Select Committee earlier this week. Mr Carney has turned more hawkish today, but not more hawkish about interest rates or sterling.

The Carney announcement will represent an important restraint on the UK housing market, which was showing distinct signs of getting too ebullient in the south east of the country. By acting early, and using methods that are distinct from the short term interest rate, this action may well make the economic recovery in the UK more durable than otherwise, though it may slow down some parts of the consumer sector in the immediate future. Read more

The recent buoyancy in global equities has raised fears that the markets have entered a major bubble, driven by the unprecedented expansion in central bank balance sheets.

To the extent central bank asset purchases have reduced government bond yields, they have certainly brought forward returns from the future into the present, thus reducing expected returns on both equities and bonds. But this is normal in a period of monetary easing, and it does not automatically mean that markets are in a bubble. Read more

Last week, the Chinese authorities created a stir when they announced that they are initiating an urgent review of outstanding debt for all of the various levels of the public sector in China, right down to individual villages. This raised market concerns, because one interpretation of this action is that the authorities may not have a handle on the amount of publicly-guaranteed debt in the economy, particularly in the local government sector, where the growth of debt has recently been extraordinarily rapid.

The authorities do not appear to have decided when (or whether) the results of this survey will be announced and of course there will be the usual suspicions that the eventual numbers will be massaged for public view. Until recently, it had generally been assumed by China watchers that, while the growth in private and corporate credit was running dangerously ahead of GDP growth, there was a major silver lining in the healthy financial condition of the government sector. Read more