The Age of Easy Money Is Nearly Over, in Test for Global Markets
(Bloomberg) -- After a decade of flooding economies with money, key central banks next year will finally start turning off the tap.
Since the financial crisis, they’ve kept interest rates near zero and some have bought trillions of dollars in government and corporate bonds. The idea was that low rates would encourage spending by businesses and consumers.
Although experts disagree about how effective the stimulus was in stoking broad-based economic growth, two conclusions are in little dispute: The deluge of cash staved off a global financial collapse, and it helped propel stocks and bonds to record levels. Now policy makers believe their economies are strong enough to thrive with less stimulus.
The U.S. Federal Reserve made the first move in October when it started allowing a portion of bonds on its $4.5 trillion balance sheet to mature without replacing them. The European Central Bank is still buying government and corporate bonds, though it recently delineated a plan for tapering off those purchases starting in January. China’s policy makers are expected to tamp down on credit growth next year, as President Xi Jinping focuses on defusing financial risks. The Bank of Japan will probably keep printing money, but that won’t be enough to offset a global decline in central bank stimulus, which economists see starting sometime in mid-to-late 2018.
“It will worry a lot of investors, because no one’s really prepared for it,” says Nader Naeimi, a fund manager at AMP Capital Investors Ltd. in Sydney who’s boosted his cash allocation to 30 percent in anticipation of pain in bonds and stocks. “It will hurt -- you want it to hurt, otherwise financial conditions will be too loose.”
In surveys, global investors identify a shift to monetary tightening as the single most likely cause of the next recession. History shows such transitions are fraught with risk. When the Fed started boosting rates in 1994, it set off the worst corporate bond slide in two decades. It also helped trigger a sudden devaluation of the Mexican peso and the ensuing Tequila Crisis.
Adding to the uncertainty: Three of the world’s four most important central bank chiefs are nearing the end of their terms and may be replaced. The same factors are likely to propel their successors toward reducing monetary stimulus. Most economies are posting solid growth. Job markets have returned to what policy makers deem full employment. American household incomes are at a record high. Crisis-wracked European countries such as Spain have recouped economic losses. China has shaken off fears of a debt crisis. Even Japan has pulled out of a long cycle of mini-recessions.
True, central bankers haven’t been hitting their inflation targets; the failure of prices to rise is one sign that growth is still subpar. But policy makers are setting that concern aside as they increasingly focus on curbing the financial excesses that could set the stage for another crash.
European Central Bank
European Central Bank President Mario Draghi vowed five years ago he’d do “whatever it takes” to save the euro. So far it’s taken more than 2 trillion euros ($2.3 trillion). That’s the amount by which he’s expanded the balance sheet. On Oct. 26 the ECB announced that its bond buying will continue through September 2018, albeit at 30 billion euros a month starting in January, or half the current pace. The institution also stressed that it will reinvest proceeds from maturing debt for an extended period.
European policy makers have been among the most forceful in their campaign to push down borrowing costs. They championed negative interest rates, which leave investors who choose to stash their money in government bonds with less than they started with. And unlike the Fed, which has confined its purchases to government and mortgage bonds, the ECB has also been buying corporate debt. In doing so, it’s extended a lifeline to European businesses that might have otherwise been forced to retrench.
That aggressiveness has never sat well with German officials, who’ve traditionally favored tighter controls to keep inflation down. Draghi’s term runs through October 2019. Any German candidate could have an inside track for the job, given that Europe’s largest economy has never had one of its own at the helm of the region’s central bank.
The Fed pumped about $3.6 trillion into the U.S. economy from 2008 to 2014. The link between monetary stimulus and markets was remarkably tight: More than half the gains in the S&P 500 from 2008 until the Fed started raising interest rates at the end of 2015 came on days the Fed announced policy decisions. That’s why, despite Chair Janet Yellen’s assurances that reducing the balance sheet will be a nonevent -- “like watching paint dry,” she said -- it’s impossible to rule out a sharp reaction in the markets.
The Fed stopped replacing some maturing bonds in October and has effectively put the process of shrinking its balance sheet on autopilot, with the rundown in assets accelerating in stages; $50 billion a month will be taken out of the nation’s bond markets by October of next year.
Yellen’s four-year term as chair is up in February, and she’s set to be replaced by Jerome Powell, who was nominated as her successor by President Donald Trump Thursday. Powell, a former private-equity executive who’s been a Fed governor since 2012, has voted in lockstep with Yellen in gradually removing stimulus and is expected to maintain continuity in monetary policy. A Republican appointed by President Barack Obama, he’s earned a reputation as nonideological and pragmatic. He sympathizes with White House calls to ease financial regulations.
Bank of Japan
BOJ Governor Haruhiko Kuroda and his board have pledged to keep stimulus going until inflation climbs above 2 percent, a level practically no economist sees on the horizon for years to come. Still, the rate of money creation will slow. One reason is that the BOJ has built up such a huge stock of government bonds -- more than 40 percent of the market -- that it doesn’t have to buy as much anymore to keep 10-year yields around zero, the target it adopted last year.
Kuroda’s five-year term ends in April. When he was nominated in 2013, his three-decade-plus tenure at the staid Finance Ministry and his optimistic, almost avuncular personality helped ensure his confirmation. Since then, he’s shaken up an institution that had long been criticized for doing too little to lift Japan out of stagnation.
Now it’s fiscal conservatives who are peeved: They say Kuroda’s easy money policies have allowed Prime Minister Shinzo Abe’s government to avoid wrestling down the largest public debt load in the world.
Their calls for a more centrist policy are likely to go unheeded in the wake of Oct. 22 legislative elections that solidified the ruling party’s hold on power. Market watchers believe that Abe, who’s said he has “complete trust” in Kuroda’s abilities, will reward him with an unprecedented second full term.
People’s Bank of China
China’s central bank is more opaque than its peers. Still, there’s a clear consensus among China watchers that officials in 2018 are likely to intensify efforts to whittle down a record buildup of debt in the financial system since the global crisis.
At the October gathering of the Communist Party leadership, President Xi Jinping reiterated that defusing financial risks is one of his top priorities. A sign of that commitment was the promotion of Liu He to the 25-member Politburo. A longtime Xi adviser on economic matters, he’s been an advocate of debt reduction.
Despite layers of capital controls, the People’s Bank of China’s actions can still roil markets around the globe. A surprise move in August 2015 to devalue the Chinese currency proved so unsettling that the Fed shelved a widely anticipated rate hike the following month.
Governor Zhou Xiaochuan has held the job for almost 15 years. The question of who will replace him became more urgent after he hinted at the recent party congress that he’s ready to retire. Even though the central bank takes instructions directly from the government, the pick for the top job still matters. Zhou’s successor will have to craft a monetary policy that balances concern about the nation’s debt load with support for an economy that’s shifted into a slower growth track.
©2017 Bloomberg L.P.