Central Banks Split on Stimulus in 2014 as Fed TapersSimon Kennedy
The united stimulus front of central banks is starting to splinter as 2014 dawns.
The Federal Reserve -- soon to be led by Janet Yellen, confirmed today by the Senate as the next chairman -- begins pulling back on its quantitative easing amid stronger U.S. growth, and the Bank of England is trying to cool its housing market. The European Central Bank and Bank of Japan lean toward more monetary action to fight weak inflation. The ECB and BOE both hold policy meetings this week.
The erosion of the mostly synchronized stimulus that supported the world economy for the past six years has investors anticipating a stronger U.S. dollar and weaker Treasuries. That’s not to say the era of easy money is over, as the need to guard against deflation -- as well as the fear of unsettling markets or upending economic expansion -- leaves the Fed and its counterparts pledging to keep interest rates at record lows.
“The world’s main central banks have very different things going on, which is an opportunity for investors,” said Scott Thiel, London-based head of the global bond team at BlackRock Inc., the world’s biggest money manager. “It’s very important to look at the economies close to inflection points on monetary policy.”
Thiel predicted last month that investors will see the Fed’s decision to taper its $85 billion in monthly bond purchases as the beginning of the end of central-bank support and will push the U.S. 10-year note toward 3.25 percent by the end of this year from 3 percent at 5 p.m. in New York Jan. 3, outpacing the projected rise in Germany’s 10-year bund yield.
Higher borrowing costs on U.S. sovereign debt and the improving economy will help boost the dollar this year, said Stephen Jen, co-founder of London-based SLJ Macro Partners LLP. The Bloomberg Dollar Spot Index, which tracks the performance of the currency against a basket of 10 peers, rose about 3.5 percent last year.
“Policy paths will be dictated by diverging economic trajectories,” said Jen, who describes himself as “generally bullish” on the dollar. “Partly because of the Fed having launched multiple rounds of QE, the dollar is now very cheap.”
Signs that the world’s largest economy is strengthening may be enough to rally equities in the U.S. and abroad, said Pierre LaPointe, head of global strategy and research at Pavilion Global Markets Ltd. in Montreal. His research shows that shifts in U.S. equities explained about 40 percent of the moves in German and U.K. stocks since 2000.
“As major central banks are set on diverging paths in terms of monetary policy, we find that the U.S. economy will have the greatest gravitational pull in 2014,” LaPointe said.
The Fed is trimming its stimulus as Vice Chairman Yellen prepares to succeed Ben S. Bernanke when his second term ends Jan. 31. The central bank will pare its monthly bond purchases by $10 billion to $75 billion this month, “reflecting cumulative progress and an improved outlook for the job market,” Bernanke told reporters after the Dec. 18 announcement.
The Federal Open Market Committee probably will continue tapering over its next seven meetings before ending the program in December, according to the median forecast of 41 economists in a Bloomberg survey last month.
The Fed announced its intentions after the jobless rate fell to a five-year low in November and as economists including Martin Feldstein of Harvard University and former Treasury Secretary Lawrence Summers predict the economy will accelerate this year. JPMorgan Chase & Co. economists raised their estimate last week for growth to 2.8 percent, higher than the 2.5 percent they projected a month ago and the 1.9 percent they calculate for 2013.
Manufacturing grew in December at the second-fastest pace in more than two years, and a report scheduled for release this week will show employers added 195,000 jobs last month, according to a Bloomberg News survey of economists.
The challenge for other central banks is that if long-term borrowing costs do rise in the U.S., this may pull up comparable rates elsewhere, threatening more-fragile expansions and forcing a response from policy makers, said Andrew Wilson, chief executive officer for Europe, the Middle East and Africa at Goldman Sachs Asset Management in London.
“Historically, markets are highly correlated, so if we see U.S. rates rising, it’s going to be hard for European rates to stay where they are,” Wilson told Bloomberg Television’s “On the Move” with Francine Lacqua on Dec. 17. “It’s going to be interesting with central banks moving in different directions.”
The ECB is already on the offensive against weak price pressures, cutting its benchmark rate to 0.25 percent in November to shore up inflation now less than half its target of just below 2 percent. Gross domestic product in the euro region fell 0.4 percent in the third quarter, and October unemployment was 12.1 percent, down from a record 12.2 percent.
President Mario Draghi has refused to rule out further cuts and pledged rates will stay low for an “extended period.” He has signaled the bank may be willing to charge financial institutions to hold their cash or offer new long-term loans.
If deflationary risks mount significantly, Draghi will need to start buying assets just as the Fed is winding down, according to Ken Wattret, an economist at BNP Paribas SA in London. Policy makers are split on whether to buy government bonds, meaning they probably would start with private-sector securities, such as assets based on outstanding loans to small-and medium-sized enterprises, he said.
The Bank of Japan, which in April intensified asset purchases and introduced a new inflation target, also may pursue more stimulus as the government raises the sales tax to 8 percent from 5 percent this April to curb its debt.
Bank officials see significant scope to boost Japanese government asset purchases if needed to achieve their 2 percent inflation target, according to people familiar with the matter. The current pace, equivalent to 70 percent of new government debt issued, isn’t a limit for many officials, the people said last month. They asked not to be named as the talks are private.
While the Bank of England indicates its benchmark rate will stay at 0.5 percent this year, it is inching toward a stimulus exit, saying in November it would dilute a credit-boosting program as housing prices, sales and mortgage demand all accelerate. Prices rose in December and will extend gains this year, property researcher Hometrack Ltd. said on Dec. 30.
Other developed-nation central banks may go even further in tightening. Economists in a Bloomberg News survey predict the Reserve Bank of New Zealand will be the first to raise its benchmark rate this year, from 2.5 percent, as accelerating economic growth and a housing boom stoke price pressures.
The risk of a premature withdrawal of support -- as inflicted by the Bank of Japan in 2000 and the ECB in 2008 and 2011 -- leaves central banks likely to use more so-called forward guidance in 2014. The theory goes that if they avoid mixed messages and signal how long they expect interest rates to stay low, investors will respond by restraining market borrowing costs, too, helping households and companies.
Fed officials have honed their message as they try to underscore that tapering isn’t the same as tightening monetary policy. The FOMC made a commitment last month to keep the benchmark federal funds rate near zero “well past the time” unemployment falls below 6.5 percent, especially if projected inflation continues to run below their 2 percent target.
Such actions were “intended to keep the level of accommodation the same overall and to push the economy forward,” Bernanke told reporters on Dec. 18.
U.S. unemployment was 7 percent in November, and the Fed’s preferred measure of inflation was 0.9 percent the same month. In Britain, with unemployment already at 7.4 percent, the Bank of England may follow by saying it won’t consider raising rates before joblessness reaches 6.5 percent or even lower, according to Brian Hilliard, chief U.K. economist at Societe Generale SA in London. Its current threshold is 7 percent, a level it now expects to be reached by the third quarter of 2015.
Even if 2014 does mark the beginning of the end of widespread global stimulus, support will be drawn down slowly. Analysts at Credit Suisse Group AG predict the balance sheets of central banks will balloon by about another 19 percent this year. Those at JPMorgan Chase estimate the average interest rate of advanced economies will be almost unchanged, at 0.33 percent at the end of the year.
The reason to keep money cheap is that price pressures still are weak and hiring fragile in most of the industrial world, with JPMorgan Chase estimating global inflation was about 2.8 percent last year, the second-lowest since World War II. Policy makers also will be wary of rocking markets as the Fed did last summer when it began signaling tapering was pending.
“The risks are more skewed in the direction of getting the timing of monetary policy wrong,” said Bill Street, head of investments for Europe, the Middle East and Africa at State Street Global Advisors in London. “There are plenty of tools to deal with inflation, but they are out of ammunition for deflation.”