Party On! The Central Bank Put Isn't Going Away
Investors have heard repeatedly in recent weeks that the period of easing by the world’s major central banks is about over. According to this view, interest-rate hikes that the Federal Reserve has already implemented will be followed by the end of bond purchases by the European Central Bank and the Bank of Japan, and by multiple rate increases by the Bank of England. Nothing could be further from the truth.
The evidence supports my belief that decision makers in developed countries are still in a market-boosting mode, and that the tightening measures are likely to be interpreted by investors as temporary and dovish rather than as hawkish. The party is not over yet!
Look first at U.S. developments. After a surge to 2.46 percent on Oct. 26, the 10-year Treasury yield slumped to below 2.35 percent on Nov. 2 (chart below). That's not much of a vote of confidence that the new tax proposals will speed the pace of economic growth, or that inflation will raise its head anytime soon. Equally important, the spread between two- and 10-year Treasury securities narrowed on Nov. 1 to 74.2 basis points, the lowest level since Nov. 7, 2007.
I recently wrote that if the Fed sticks to its plan to raise the federal funds rate in December, and another three times in 2018, that would push the two- to 10-year spread even narrower, possibly to a negative level. That would increase the likelihood of a recession.
Such fears probably explain Fed Chair Janet Yellen’s recent statement that monetary easing measures should remain a part of the central bank’s arsenal. Speaking at the National Economists Club on Oct. 20, she emphasized that “we must recognize that our unconventional tools might have to be used again.” That does not sound like a Fed chief who is preparing the market for an increasingly restrictive monetary policy.
Finally, the nomination of Jerome Powell to be the next Fed chairman, starting in February 2018, reflects President Donald Trump’s choice to have a central bank head who is in line with his preference for low interest rates and less regulation of the financial sector. U.S. financial markets cheered the Powell pick by pushing equity prices higher and Treasury yields lower.
Turn now to Europe. There had been high expectations that the European Central Bank would not only announce a reduction in the quantitative easing program at its meeting on Oct. 26, but also an end date for the plan and an indication of when interest rate hikes would occur. The refinancing rate has been at zero, and the deposit rate at minus 0.4 percent, since March 2016.
Although ECB President Mario Draghi announced that monthly bond purchases would be halved from the current 60 billion euros ($70 billion) to 30 billion euros effective in January, he set no end date for the program. Consequently, the market consensus is that quantitative easing may continue into 2019. Key interest rates were also left unchanged. Those developments were viewed as dovish and the euro weakened markedly (chart below). The region’s sovereign bond yields fell, too.
In London, after having signaled a rate hike several times without following through, Bank of England Governor Mark Carney finally announced an increase on Nov. 2 -- the first in 10 years. However, with Brexit-related uncertainties influencing economic policy, this may turn out to be a “once-and-done” strategy rather than the start of a process of serial tightening. Some investors even fear that the central bank may be forced to reverse the rate hike if the economy weakens markedly. Rather than appreciate after the monetary tightening, the pound fell sharply.
You will not see warnings of monetary tightening from Japan either. Prime Minister Shinzo Abe’s party won a landslide victory in elections held Oct. 22, allowing him to continue the stimulative policies he has favored. Speculation is growing that Haruhiko Kuroda, under whose leadership the Bank of Japan increased its balance sheet to an unprecedented 100 percent of gross domestic product, may be reappointed in April.
The message for investors: The Yellen-put, Draghi-put, Carney-put and Kuroda-put are all very much alive. That means the three decade-long bond rally is likely to continue, even as the speculative bubble in equities gets bigger.
Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.
To contact the editor responsible for this story:
Max Berley at firstname.lastname@example.org