You’ve Been Warned: Central Bankers Turning Less Market-FriendlySimon Kennedy
Some things seem permanent. Greece is fighting for a bailout. A Bush and a Clinton are running for the White House. FIFA is plagued by scandal.
But for those who track the world’s central banks, change is afoot.
Having soothed investors for the past seven years with low interest rates, bond-buying and other interventions aimed at shoring up weak economies, monetary policy makers are slowly stepping out of markets in a variety of ways.
That leaves investors facing renewed bouts of the volatility which marked recent weeks. A record number of investors told Bank of America Merrill Lynch this month that they have taken out protection against falling stocks over the next three months.
“2015 will go down as the year when major central banks hit an inflection point in their willingness to distort and manipulate markets,” said Alan Ruskin, global head of Group of 10 foreign exchange at Deutsche Bank AG in New York. “This mix of overt and subtle withdrawal of market support is a key macro driver of recent increased volatility.”
Behind the switch in stance is the suspicion that markets risk becoming distorted and overly-reliant on policy makers for direction and need weaning off. If the price is a bit of turbulent trading now then so be it.
There may be a “strategy to accept higher volatility rather than risk even greater shocks further down the road by allowing potentially destabilizing disequilibria to build further,” said Michala Marcussen, global head of economics at Societe Generale SA in London.
The first to implement a major policy shift was the Swiss National Bank, which rocked markets in January by unexpectedly scrapping its three-year policy of capping the franc at 1.20 per euro. The currency is now around 1.05.
Having forced bond yields down and often into negative territory with a 1.1 trillion euro ($1.2 trillion) quantitative-easing program, European Central Bank President Mario Draghi is now responding to a sell-off in bonds by telling markets to get used to more volatility and warning low interest rates “may increase the financial stability risk.”
The average yield across the euro region climbed to 1.08 percent on Monday, BofA Merrill Lynch indexes show. That’s more than double a record low of 0.425 percent, reached just three months ago.
As for the Bank of Japan, Governor Haruhiko Kuroda last week questioned the yen’s slide to a 13-year low that his stimulus helped facilitate, by saying the currency “is unlikely to weaken further in real effective turns.” While he said on Tuesday that comment wasn’t aimed at influencing the exchange rate, the yen is still higher than a week ago.
Wednesday is the turn of Federal Reserve Chair Janet Yellen to talk after U.S. policy makers convene in Washington. Haunted by the taper tantrum of 2013, Yellen is nevertheless still trying to pave the way to the first U.S. interest rate increase since 2006, potentially as soon as September. Sounding the alert to investors, she’s already dropped assurances that rates will stay low and said both stocks and bonds are richly valued.
“Yellen has also warned on the topic of financial stability,” said Marcussen. “Indeed, not raising rates also carries risks.”
Not all are concerned central banks are turning their backs on markets. Even as they warned the risk of an equity bubble is as high as 70 percent, Credit Suisse Group AG strategists said in a report last week that policy will remain “abnormally loose.”
The ECB and BOJ are still purchasing bonds and authorities in New Zealand and South Korea last week cut rates even at the potential price of asset-price growth. The Fed is signaling that when it does increase borrowing costs, it will do so gradually.
Still, investors may want to heed last week’s warning from Bank of England Governor Mark Carney if they continue betting on central banks always running to the rescue.
“The possibility of unpredictable changes in market liquidity poses a clear risk to financial stability, particularly when some market participants take liquidity for granted and crowd into trades in anticipation of central bank action,” he said.