In mid-2013, the then chairman of the Federal Reserve, Ben Bernanke, suggested that America’s central bank should start to cut back on the purchase of bonds that had started in 2008. The turmoil resulting from this announcement on all markets in general, but on emerging markets in particular, put a curb on his intentions.
The baton was passed on to Janet Yellen, who in December 2015 approved a rise of 25 basis points on interest rates that had remained at 0% for seven years. The last increase had taken place in 2006, but with scant resonance – Twitter was yet to come into its own. In just a little over a month, between 22 December 2015 and 28 January 2016, the Chinese stock market adjusted by just over 27%, and plans to normalise monetary policies had to be postponed once again.
This time around, it seems that not just the Fed, but other major central banks such as the European Central Bank, the Bank of England and the Bank of Canada, are willing to normalise monetary policies, following almost ten years of emergency policies.
The global economy is now more settled. The OECD expects the world’s GDP to grow in 2017 and 2018 to levels of 3.5% and 3.6%, respectively, in comparison with the average of 3.9% between 1987 and 2007. However, developed economies will grow at slower rates, nearer to 2%. The United States has grown by an average of 1.47% over the past eight years, as compared with 3.4% since the Second World War, and the annual real growth rate since the last recession was just 2.1%, in comparison with an average of 4.5% in previous recoveries. Based on figures published to date, it does not seem that growth will even reach 2% in the first half of 2017.
The Federal Reserve’s task is further complicated by two historical facts: since the Second World War, the Fed has triggered 13 cycles of rises in interest rates, ten of which took the economy into recession. Secondly, since Ulysses S. Grant (1869) all republican presidents have experienced a recession during their first term of office. Nevertheless, as athletes often say, if faced with a challenge backed by past results against winning, records are there to be broken.
The desired rate of inflation (for the central bankers that govern us because, I do not know about you, but I like to buy things when they go down in price) closed at 1% in 2016 in developed economies and, unless there are new price rises in oil, it seems unlikely that the target of 2% will be reached.
Finally, global debt, far from dropping, has continued to grow. By the close of the first quarter of 2017, it was 217 trillion dollars, which meant that it increased by more than half a trillion dollars, 46% higher than ten years ago. Developed economies have built up a total debt of 160.6 trillion dollars, 1.4% down on the previous year, whilst the debt of emerging countries reached 56.4 trillion dollars, up by 5.4%.
In light of positive economic growth, although perhaps not sufficiently sound to deal with potential upheavals, a controlled rate of inflation still way off target and higher debt levels in the economy, what has made central banks act like this now?
Even the chief economist of Bank for International Settlements highlighted in its annual report published last month that:
“Policy normalisation presents unprecedented challenges, given the current high debt levels and unusual uncertainty. A strategy of gradualism and transparency has clear benefits but is no panacea, as it may also encourage further risk-taking and slow down the build-up of policymakers’ room for manoeuvre.”
Perhaps central bankers have (at last) realised that inflation is in financial assets – the returns on the oldest bonds in history, those of the United Kingdom and the Netherlands, have seen the lowest in 322 and 500 years respectively, whilst the US had 10-year bond yields of 1.366%, the lowest since 1800. Maybe it has taken them too long to withdraw these measures that are now not only ineffective, but also encourage too much risk-taking, which puts financial stability at jeopardy. It could simply be that they are recharging their arsenal of weapons to shore up monetary policies should they need to use them in the near future.
Whatever the reason, the reality is that the market has let them get away with this so far. The question is: will this go on like this? Will they stay on course if the market does not take this well? If they do not keep a steady hand, will faith be lost in the omnipotence of central banks? It should not be forgotten that low interest rates have been the main driver behind the upturn of financial markets.
If Ben Bernanke was right about the positive effects of rolling out quantitative easing, he should be equally right about the effects of withdrawing it. Without going into specifics, what is important is that markets believe so, and think that central banks are responsible for the positive performance of markets.
In response to the appearance of another financial crisis, Janet Yellen was clear in a recent interview: “Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”
Overall, the four big central banks have purchased around $13 trillion in bonds ($13,000,000,000,000). It goes without saying that divesting this portfolio without messing things up is not going to be an easy task…
Column by Alfredo Álvarez-Pickman chief economist at Banco Alcalá, part of Crèdit Andorrà Financial Group Research.
For Fórmate a Fondo
For Alicia Miguel