Commentaries
PMC Weekly Review - August 12, 2016
A Macro View – Pushing on a String: Have Central Banks Run Out of Ammunition?
Despite the lack of success by the European Central Bank (ECB) and Bank of Japan (BOJ) in generating economic growth with their quantitative easing programs (QE), they are now joined by the Bank of England (BOE), which has embarked on a QE program of its own in an effort to cushion the UK economy from the impact of the country’s recent decision to leave the European Union (Brexit). Last week the BOE cut interest rates to an all-time low of 0.25% and committed itself to buy £60 billion in government bonds, or gilts (aimed at driving down gilt yields and forcing investors into riskier assets), and an additional £10 billion in corporate debt issues. This decision comes after the bank initially opted to leave rates unchanged at its meeting in early July, the first meeting following the Brexit referendum. Since then, however, UK economic data points to a marked slowdown, and the BOE slashed its
growth expectations for 2017 by nearly two thirds, from 2.3% down to 0.8%.
The initial implementation of this QE program met resistance from the bond market this week. The BOE failed to complete a £1.17 billion purchase of long-dated gilts (15+ year maturities), as pensions and insurance companies were reluctant to sell to the bank in Tuesday’s reverse auction. However, this segment of the market is considered to be less liquid, and the summer holiday season may have exacerbated the issue. The BOE was far more successful on Wednesday in its £1.17 billion purchase of intermediate maturity gilts (7-15-year maturities), as the market offered nearly five times more bonds than the bank sought to buy. The BOE also has been successful thus far in its goal of driving down yields, as the yield on the 10-year gilt has dropped toward 0.5%, down from 0.7% last week. But questions remain as to whether or not the BOE will have more success in its second attempt to purchase longer-dated gilts next Tuesday.
Two weeks ago, at its July 29th meeting, the BOJ announced it would continue to ease its policy by doubling ETF purchases, but it failed to meet market expectations, by declining to either expand its government bond-buying program or to take rates further into negative territory. There also was speculation leading up to the meeting that the bank may take a more drastic approach, implementing “helicopter money”, or essentially monetizing government debt. The underwhelming stimulus resulted in a selloff of the Nikkei and a sharp rally in the yen/dollar exchange rate. Even prior to the news, the yen had been strengthening against the dollar for several months (+15% YTD), despite the massive stimulus, leading to skepticism that the bank’s QE program may be losing its effectiveness. Further questions arose about the BOJ’s commitment to the program after it announced that it would conduct a “comprehensive assessment” of its monetary policy at its meeting in September. This led to the bank’s release of a “preliminary outline” on Monday for the upcoming meeting, in what may have been an attempt to assuage investors who were speculating that its QE program might be winding down. The yen has rallied roughly 3% against the dollar since the July 29th meeting, and the currency continues to act as a hindrance to the 2% inflation target BOJ Governor Haruhiko Kuroda is striving to reach.
This raises the question: Are central banks reaching their limit in experimenting with monetary policy as a means to stimulate economic growth? Although a concrete answer is yet to be determined, concerns are mounting that the continuing slump in
global growth may be indicating a lack of effectiveness. One certainty is that such low yields abroad have continued to drive up foreign buyers’ demand for US fixed income securities. This, in turn, keeps a lid on Treasury yields, regardless of the strength of the underlying US economic data, while demand for the dollar exerts downward pressure on inflation, which places the Fed in somewhat of a predicament. The Fed clearly desires to raise interest rates to provide a larger tool box should it need to stimulate the economy in the future, but it has struggled to find the premise to do so in this environment. For now, the market continues to price in about a 50-50 probability of a Fed rate hike by the end of the year, while the BOJ, ECB, and now the BOE attempt to keep calm and carry on with QE, despite the lack of results.
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