Traders Remind Central Banks to Take Care on Route to Exit DoorBy
BOJ, PBOC, ECB have all jolted investors eying policy shifts
Lesson is to be careful when anything can be taken as a signal
Global central banks are being served a sharp reminder by investors that their monetary policy planning carries the potential to roil financial markets in 2018.
A minor tweak in the Bank of Japan’s bond-purchase operation Tuesday saw the yen strengthen more than 1 percent in two days. A change in the way China’s central bank manages the yuan sparked losses in that currency while recent hawkish comments from European Central Bank officials nudged the euro higher.
The lesson, almost five years since the Federal Reserve sparked the so-called taper tantrum, is that markets are on high alert for any insight into how and when central banks intend to withdraw the emergency stimulus they adopted following the financial crisis.
“Mitigating the downturn and the crisis was always going to be the easy part,” Neil Mellor, a currency strategist at Bank of New York Mellon Corp. “Extricating the global economy from that monetary accommodation was always going to be more difficult.”
With bonds already in the grip of a selloff, and luminaries such as Bill Gross at Janus Henderson Group declaring a bear market, policy makers are under pressure to be more careful than ever in their communications.
They’re treading a fine line with forward guidance, the tool favored by the ECB and Bank of England. Should the signals come too early, or if they’re misinterpreted, it risks creating market volatility that can undermine the path to action.
The world’s exit from extraordinary stimulus is proving long and bumpy. Central banks have been stuck firmly in expansionary mode for most of the past decade, leaving investors starved of any serious signs of interest rate hikes or truncated bond-buying. That’s why they have so often jumped on smaller signals as evidence of a imminent change.
The BOJ’s cut in long-term bond purchases on Tuesday is a classic example, with markets reacting even as central bank watchers said the move doesn’t have a major policy implication and shouldn’t be taken as a new sign of a turn to the exit.
“Because the BOJ has not provided the kind of clear forward guidance the ECB has provided, markets will respond aggressively to any signals, real or imagined,” Krishna Guha, vice chairman at Evercore ISI in Washington, wrote in a note.
As for the ECB, the euro has risen more than 1 percent since policy makers last met as several rate-setters stoked speculation that bond buying could end in September, and investors are keen to learn where President Mario Draghi stands in the debate.
A bigger test may come if the Fed is forced off the path of gradual interest rate increases it’s signaling this year. Jan Hatzius, chief economist at Goldman Sachs Group Inc., told Bloomberg TV on Wednesday he still expects the U.S. central bank to raise its benchmark on four occasions this year rather than the three times policy makers now signal.
Changes in central bank leadership may further complicate matters. Jerome Powell takes over the Fed chair from Janet Yellen in early February, and a new vice chair has yet to be named. The ECB is replacing several voters this year, with Draghi due to leave in 2019. BOJ Governor Haruhiko Kuroda’s term expires in April, though he may stay on for another.
Central banks are well aware of the risks of rowing back. In May and June 2013, then-Fed Chair Ben S. Bernanke signaled the institution might slow its bond buying. That caused sovereign debt markets to plummet led to turbulence in emerging markets.
Then last June, markets whipsawed after Draghi, and his U.K. and Canadian counterparts, made speeches in Sintra, Portugal, that were interpreted as indicating moves toward tighter policy. The flipside of that episode was that, when all three banks did announce a change in policy later in the year, the reaction wasn’t that severe.
More recently, Kuroda had to account for comments he made about an economic theory that could justify a future boost in interest rates. The Riksbank moved the Swedish krona to a two-month high against the euro on Wednesday after minutes of the December meeting were slightly more hawkish than investors expected.
That highlights the perils of any perceived change in a bank’s guidance. If sustained, a jump in currencies acts as a de facto tightening in itself, potentially reducing the likelihood of a policy change, which, in turn, risks even more volatility further down the road.
“Central banks might prove a bit more reticent to lift policy rates if their trade-weighted exchange rate is rising sharply and so creating quite a monetary squeeze,” said Steven Barrow, a strategist at Standard Bank.