Instead of Great Divergence, Central Banks Are Converging Againby
Fed yet to deliver 2016 rate hike; BOJ, ECB rethinking policy
Aging, slow productivity growth reduce equilibrium rate
This was meant to be the year of monetary policy divergence. Instead, major central banks’ paths -- albeit on different trajectories -- are converging once more.
The Federal Reserve held fire Wednesday and scaled back tightening plans. Hours earlier, the Bank of Japan tweaked its stance to target a gap between short- and long-term yields to aid the financial industry. The European Central Bank is reviewing its go-for-broke stimulus approach while keeping ultra-easy settings, the Bank of England is expected to cut again, and China is keeping liquidity ample.
Unifying the world’s central banks is recognition it’s going to be a long hard slog to lift inflation to targeted levels, and that slow productivity growth and aging populations have cut potential growth and long-run neutral borrowing costs.
"Interest rates are lower for longer everywhere," said Michael Every, head of financial markets research for Asia-Pacific at Rabobank International in Hong Kong. "It is a structural function of the dysfunctional global economy that we have."
While that’s good news for asset markets -- ten-year Treasuries are trading near a two-week high -- another few months of rallying bond markets is set to make exiting today’s crisis-level policy settings tougher still. If and when expectations for higher rates do take hold, losses in the $100 trillion global bond market could pour cold water on any economic recovery.
"Raising interest rates or unwinding asset purchases could further slow the global economy and maybe even cause the next recession," David Lafferty, chief market strategist, Natixis Global Asset Management, wrote in a recent note. "While we acknowledge this risk, we believe central banks have reached a tipping point where the negative side effects of extraordinary policy now seem to outweigh its ever-diminishing benefits."
And so there’s a catch-22 at work: tighten policy and hurt growth or maintain ultra-loose policy and raise the risk of asset-price bubbles.
The BOJ is responding with innovation, and not for the first time. After its adoption of a European-style negative interest rate on some bank reserves resulted in an outcry from banks and plunge in yields, it has switched to a strategy of targeting the yield curve. The move to hold 10-year yields around zero and let longer-dated securities stay positive is aimed at both making the framework more sustainable and reducing negative side effects.
Mario Draghi and the ECB, meantime, are studying how to ensure their quantitative-easing program still has enough bonds to buy. With more than 60 percent of German sovereign debt with yields below the deposit rate, and thus ineligible for purchase under the ECB’s self-imposed rules, the institution is faced with the risk of running out of debt should it decide to extend the duration of QE.
Fed Chair Janet Yellen, who described policy Wednesday as “only modestly accommodative,” played down concerns the Fed’s stance was fueling bubbles in financial markets and the economy. “In general, I would not say that asset valuations are out of line with historical norms,” she said.
But there’s a vocal list of investors who dispute that, with Janus Capital Group’s Bill Gross describing negative-rate bonds as a "supernova that will explode one day."
Caught in the middle are small, open economies like Australia and New Zealand. Their relatively higher yields continue to attract investors, driving renewed currency gains and pushing down the price of imported goods. Even as housing prices surge in their biggest cities, more rate cuts may be needed to dissuade international capital and help underpin inflation.
For his part, newly installed Reserve Bank of Australia Governor Philip Lowe on Thursday offered counterpoints to the narrative that inflation and wage gains are a thing of the past, and that central banks need to be in the business of perma-easing.
Weak compensation increases in the developed world are a "persistent but temporary" trend, due to workers feeling more global competition, Lowe said. But if job growth continues, pay rises will pick up. "It’s quite unlikely that we get stuck in a very low wage growth world." And when pay gains pick up, inflation will pick up, he said.
In a parliamentary hearing, Lowe also played down the chance of the RBA following its peers into doing "incredibly unusual things" with policy. He did acknowledge that advanced economies are challenged by brakes on growth unlikely to lift soon -- singling out high debt levels hurting consumers’ ability or desire to spend, and the demographic impact of aging.
With such headwinds, policy re-convergence has given the ECB and BOJ a window to reconsider their approaches.
"The much lower pace of tightening by the Fed has allowed central banks in other parts of the world to increase monetary stimulus," said Klaus Baader, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. "If anyone has converged with the rest of the world it’s the Fed."