JAMIE MCGEEVER: Want to understand central banks? Start with the Hotel California lyrics
When it comes to extraordinary easing measures like QE and zero or negative interest rates, as The Eagles put it in ‘Hotel California’: “You can check out any time you like, but you can never leave”
Not for the first time in the past 20 years, the challenges of global monetary policy making have been laid bare by the Bank of Japan. By opting not to tighten policy on Tuesday, as it had looked like it might, the BOJ highlighted how difficult it is for central banks to unwind extraordinary, crisis-era policy before the economy turns, no matter how much they may want to.
It was another reminder that when it comes to extraordinary easing measures like QE and zero or negative interest rates, as The Eagles put it in ‘Hotel California’: “You can check out any time you like, but you can never leave”.
For investors, any signal, no matter how small, that policymakers are preparing to reverse crisis-era stimulus can have an outsized impact. Recent hints from the BOJ along these lines helped lift the 10-year Japanese yield to its highest level in a year and a half as of earlier on Tuesday.
In an ideal world, central bankers would be unwinding much faster. Low and negative rates hurt banks, and a solid financial system, in theory, is needed to spur lending, investment and ultimately growth.
Policymakers also want ammunition to fight the next crisis or economic downturn. Raising rates and reducing their balance sheets would give then more leeway to cut and expand, respectively, when the time comes.And that time might be soon, because the global expansion is long in the tooth. But the scars of 2007/08 run deep, and tightening too much too soon risks triggering the downturn they’re so desperate to avoid.
Inflation too, for the most part, remains below target, further complicating any plans to unwind extraordinary policies.
The BOJ was the first major central bank to adopt these policies back in the 1990s to fight off deflation. Two decades and a global financial crisis later, it’s in deeper than ever, and struggling to exit.
It owns around $4.8 trillion of assets, mostly bonds. The Japanese government bond market is the second largest in the world at around $9 trillion, and the BOJ owns around 45 pct of it. It is also buying up more equities and related products.
“It does seem as if it can’t abandon the current policy but, at the same time, it can’t continue forever – or do we really envisage that the BOJ will end up owning all bonds and all stocks?” said Steve Barrow, G10 strategist at Standard Bank.
Where the BOJ led, others followed. The Fed, European Central Bank and Bank of England all took the plunge into quantitative easing and zero interest rate policy (ZIRP) in response to the 2008 crisis, with the ECB adopting negative interest rates too.
A decade later, to varying degrees, all are still stuck in the extraordinary policy vortex.
Comparatively speaking, the Fed is well down the path of normalization, slowly but surely raising rates for the past three years and now beginning to run down its $4.5 trillion balance sheet.
But it is a slow process. And once it’s complete the Fed’s bond holdings and other assets will still be around $3 trillion by early 2021, according to the New York Fed. That’s a far cry from a projected $2 trillion back in 2015, and well above pre-crisis levels of $750 billion-$900 billion.
The ECB plans to end its 2.6 trillion euro bond-buying programme later this year and raise rates late next year. But its balance sheet is now 4.5 trillion euros. There’s no hint of when it will get back to anything near pre-crisis levels of under 1 trillion euros.
Similarly, the BoE may have put its QE programme on hold and be about to lift borrowing costs ever so slightly higher, but the chances of its balance sheet and interest rates returning remotely close to pre-crisis levels any time soon are zero.
On an aggregate basis, thanks to the Fed, G4 central bank interest rates are rising and balance sheets are no longer expanding. The withdrawal of global liquidity is underway, however slowly.
But as the BOJ showed again on Tuesday, the gulf between wanting to exit and actually exiting can be huge. As The Eagles might say: “We are all just prisoners here of our own device”.