Major Central Banks Are Too Hawkish

(Bloomberg Opinion) -- Global investors are positioned for a coordinated tightening of monetary policy by the world’s major central banks. Although the U.S. Federal Reserve is already far down that path, the others are just getting started.  The European Central Bank is set to end its bond purchase program by year-end. The Bank of England is leaning toward hiking interest rates for only the third time in 10 years. Concerns were rising that the Bank of Japan could end the zero yield target for 10-year government bonds at its meeting last month.

Rather than join the herd in exiting fixed-income assets, investors should pay attention to indicators that suggest that the bond bears’ concerns about a strengthening economy are exaggerated. There are enough negative factors facing each of these central banks to make them reconsider, which would underpin not only debt securities but equities as well.

A factor that may induce the Fed to delay rate increases after September is the surging dollar. U.S. President Donald Trump has already complained that an appreciating dollar has blunted the “competitive edge” of U.S. exports. By increasing the cost of American exports to foreign buyers, a stronger dollar would increase the trade deficit that Trump considers to be an important measure of how other countries are taking unfair advantage of the U.S. On July 19, he openly criticized the Fed for increasing rates several times despite a long-held tradition that the executive branch avoids commenting on monetary policy.

The ECB has to contend with a deteriorating economic situation in Turkey, which owes $467 billion to foreign creditors, including a large exposure to some of the euro zone’s largest commercial banks. The banks may have to write off a portion of their loans to Turkey, requiring an ECB backstop for vulnerable financial institutions rather than tighten monetary policy into a crisis. The central bank also has to deal with rapidly rising Italian sovereign bond yields due to the expansionary fiscal measures of the populist government that took office this year. Ending ECB bond purchases, or increasing the main refinancing rate above the current zero level, could increase bond yields in the region’s southern fringe.

The Bank of England increased the official bank rate on Aug. 2 for only the second time in 10 years. In explaining the decision, Governor Mark Carney suggested that growth was rebounding and inflationary pressures were building. Foreign-exchange traders reacted to the hawkish statement by pushing sterling lower. With uncertainty about the U.K.’s future relations with the rest of the European Union just a few months before Brexit becomes effective in March 2019, the central bank may not be able to tighten again. The pound has been on a relentless decline this month.

The Bank of Japan concluded a meeting on July 31 by maintaining its zero target for the 10-year bond yield. The central bank justified its decision by confirming what we already knew, which is that despite five years of massive monetary stimulus, it was far from achieving its goal of a 2 percent annual inflation rate. Price increases have not met the 2 percent target anytime after March 2015, and consumer prices rose by a mere 0.7 percent in June.

The message for investors is not to believe the tough rhetoric coming from central bankers but instead watch their actions and follow the data. The data suggest that rather than a tightening, markets may have to get ready for more easing during coming months. While the reasons for policy shifts may vary — overly strong dollar, contagion from Turkey, Brexit-related fears or near-zero inflation rates — the result is likely to be a more or less synchronized easing.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Komal Sri-Kumar is the president and founder of Sri-Kumar Global Strategies, and the former chief global strategist of Trust Company of the West.

©2018 Bloomberg L.P.