Central Banks

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

The financial shock which has recently hit the emerging markets stemmed in part from a period of severe stress in the Chinese money markets, which has now been brought under control. But the challenges facing China are chronic, not acute. And since the country is much more than “first among equals” in the Brics, a prolonged slowdown in its economy would keep all emerging market assets under pressure for a long while.

Although China is probably not facing anything as dramatic as a “Lehman” moment, it will need to spend several years tackling the combination of excess credit and over-investment that has followed the Rmb4tn ($652bn) stimulus package of 2008. Hailed at the time as a masterstroke, the package has caused a hangover that has now been implicitly acknowledged by the new administration under reformist Premier Li KeqiangRead more

For many years, one of the most enduring mantras of central banking was along the lines of “we never pre-commit to future actions, because all of the information we have about the state of the economy is already contained in the actions we have just announced”. Now that has been completely abandoned. With the ECB and the BoE changes announced today, the central banks are shouting from the rooftops that “we are all forward guiders now”.

In the old days, if the central banks wanted to ease or tighten policy, they just adjusted the size of the change in interest rates at any given meeting, and allowed their actions to speak for themselves. The forward path for short rates was generally very sensitive to any given change in the policy rate, so they did not have to worry too much about the impact of their policy on the yield curve. Read more

Central bankers nowadays have the power to move the global markets by uttering nothing more than a brief, off-the-cuff remark. “Whatever it takes,” was Mario Draghi‘s version, which saved the euro last year. “In the next few meetings,” was Ben Bernanke’s equivalent last month. There will be rapt attention turned on the Fed chairman’s press conference on Wednesday to see whether he retracts that remark, which of course relates to the time when the Fed might start to slow the pace of its asset purchases.

Mr Bernanke does not carelessly throw out such remarks, so it would surely be incoherent for him to withdraw it completely this week. The Fed is unlikely to have been particularly troubled by the bout of market volatility seen lately. Much of it has come in foreign markets, which are not the Fed’s responsibility. Meanwhile, in the US itself, the reversal of the “reach for yield” is precisely what the Fed has been wanting to see for several months.

The killer phrase “in the next few meetings” is therefore likely to remain on the table after the press conference on Wednesday. However, the Fed chairman will hammer home exactly what he means by this message, since there are signs that it has been misunderstood by investors. In particular, the US Treasury market is sending some messages which should worry the Fed. Read more

The ECB decided yesterday against “going negative” by reducing its deposit rate from zero to -0.25 per cent. The Governing Council again debated the pros and cons of such a measure, which would represent the first time that any of the major four central banks would ever have reduced a key policy rate to below zero [1]. Mr Draghi said again that the ECB was “technically ready” to take this action, and that the option remains “on the shelf”.

Many in the markets believe that this is just a bluff to prevent the euro from rising in the foreign exchange markets. There have been several unsupportive comments from leading members of the Governing Council (Asmussen, Mersch, Noyer and Nowotny) and Mr Draghi admitted that disagreements exist in the Council. Nevertheless, the President has deliberately left the option on the table, so it is important to understand the debate.

The technical aspects of negative rates have been very well covered in FT Alphaville recently, but I would like to focus on the broader policy implications. Why would a central bank want to take this action, and could it back-fire on them? Read more

The month just ended was the fourth worst month for government bond returns in the past two decades. This abrupt response to Ben Bernanke’s warning that the Fed might think about tapering QE at some point in the next few meetings has naturally raised fears that the great bull market in fixed income, which started in 1982, might now be threatened by a sharp reversal.

Some analysts regard this as the inevitable bursting of a bubble which has been created by the actions of the central banks (see this earlier blog). Others, like Jim O’Neill, regard the rise in bond yields as the start of a return to economic normality, and argue that would be a very good thing as long as it occurs in an environment of recovering economic confidence. Paul Krugman also points out that the pattern of behaviour in the major markets – bonds down, dollar up and equities up – is consistent with greater optimism about the US economy, rather than worries about the Fed or the onset of a debt crisis. Read more