Central Bank Normalization Isn’t as We Know It, Davos Panel SaysBy and
Policy makers and adviser speak at World Economic Forum
Strong dollar is a key headwind to higher U.S. interest rates
Central banks globally may not be pumping in quite so much monetary stimulus as inflation picks up, but they’re a long way from returning to normality.
That’s the view of commentators including Swiss National Bank President Thomas Jordan, UBS AG Chairman Axel Weber and Anthony Scaramucci, an aide to President-elect Donald Trump, at the World Economic Forum in Davos, Switzerland.
“If anybody in this room thinks that we are in an interest-rate normalization, we are frankly not,” Scaramucci, the founder of hedge fund Skybridge Capital, said in the panel discussion on Tuesday. Jordan said that while it is a “very positive sign” that the U.S. Federal Reserve has started to raise interest rates, “I would expect that at all central banks, and especially in the U.S., the movement will be gradual.”
The global financial crisis almost a decade ago and the slow recovery of major economies since then has taken monetary-policy makers into uncharted territory, including negative rates and massive bond purchases, that will likely take years to unwind. A stronger dollar as the U.S. outperforms its peers is further reducing the need for officials at central banks in Europe and Asia to rein in their stimulus.
“The expansionary policies of Japan and the ECB more than outweigh the reluctant tightening of the Fed,” said Weber, a former European Central Bank official. “Monetary-policy normalization is not going to happen. You’re going to more likely see the Fed at some point smooth the pace out and move less on interest rates.”
The Fed increased rates last month for the first time in a year and indicated that they expect to raise them three times in 2017. The pace of tightening is “the slowest of any normalization” since the U.S. central bank was founded in 1913, Harvard Kennedy School Professor Carmen Reinhart said on the panel. The strong dollar suggests a “more moderate pace of normalization,” she said.
At the same time, the ECB has extended its bond-buying program and the Bank of Japan has reaffirmed its intention to keep 10-year bond yields at about zero. The Bank of England, facing higher inflation and slower growth as the country prepares to leave the European Union, says its next rate move could be up or down.
The Fed’s tightening may be illusory, as global capital flows exit emerging markets and return to assets in the world’s largest economy, argued Li Daokui, a professor at Tsinghua University and a former adviser to the People’s Bank of China.
“The U.S. monetary condition is actually very loose,” he said. “That’s why the housing market is going up. That’s why the stock market has been setting new records.”
Moreover, the tightening may not last long as the U.S. is late in its economic cycle, the panelists warned. Much might depend on the pace of appreciation of the dollar, which on a trade-weighted basis increased more than 9 percent from its May low to its December high. A stronger greenback makes U.S. exports less competitive and dampens inflation.
Weber estimated that the U.S. currency has about another 10 percent to “play out” over the next 12 to 15 months.
That also carries spillover risks given the $4.5 trillion in dollar-denominated, emerging-market corporate debt, according to David Rubenstein, co-chief executive and co-founder of The Carlyle Group.
“The Fed has to really take into account the impact of the currency,” he said on the panel. “We do run the risk of potentially another Mexico-type crisis where the dollar is so strong that people who borrowed money in dollars cannot repay them, because they’re earning money in local currency.”
His suggestion? Another reserve currency.
“If the renminbi could be made a reserve currency at some point, “that would solve some of the problems we have today,” he told Li, who responded: “That’s a long-run issue.”
For more on Davos, see our special report on the World Economic Forum 2017.