Media coverage of monetary policy has become hysterical. The acreage of news and comment being devoted to the tiniest hint of movement in official interest rates either upwards or downards goes against a central maxim.
Mervyn King, governor of the Bank of England before the current incumbent Mark Carney, summed it up neatly with a famous remark that he made in 1997. The hallmark of a well conducted monetary policy is that it should be boring, he said.
Try telling that to the serried ranks of reporters and news editors at the likes of the Financial Times and Bloomberg. Hardly a minute passes in geo-economic time without a headline howling about the imminence of monetary Armageddon.
Finance a spectator sport?
Either international finance has become a spectator sport meriting a non-stop running commentary. Or behaviour has been distorted by the relentless demands of 24/7/365 news outlets.
Perhaps a memo should be issued to overexcited teenage scribblers. A four basis points rise in the US 10-year treasury bond yield to 2.36% is hardly a sign that the US bond market is rattled.
Likewise a one basis point move in German bund yields. Even more so a two basis points in Italian government bond yields. These are surely not indicators of markets under siege. Keep calm and carry on might be sound advice.
Panic and rattling
A 50% increase in the Bank of England base rate to 15% as happened on 16 September 1992 (Black Wednesday) was a significant move. It reeked of panic and rattled markets. As did the decision later that same day to cut it to 12%.
To anyone who remembers the UK annual inflation rate nudging 25% (1975), Bank of England base rate at 17% (1980), a four basis points shift is a rounding exercise, almost literally nothing. Especially to investors who fully intend to hold stocks to maturity.
Going back to basics is often a good tactic in interesting times. Yields are rising because bond prices are falling. Bond prices are falling because of suggestions that the end of extraordinarily loose monetary policy in major markets is nigh.
Fed's baby steps
The US Federal Reserve Bank is as yet the only central bank in a developed market economy to take steps towards so-called normalisation of interest rates. The steps have been baby ones, but the direction of travel is clear: upwards.
This is despite the misgivings expressed by many a long-term market observer. Despite the weakness of key metrics such as growth and inflation. Despite the fears of people at the bottom of the pile that they are not waving but drowning.
What about the professionals?
Nicolas Simar, head of Equity Value Boutique at NN Investment Partners expects investors in Europe to switch their appetite from bonds to value stocks, which have a strong positive correlation with rising bond yields and are now seeing improving earnings.
Investors have favoured bonds and their proxies in the first half of the year because of political risks and low inflation, he notes. But recent comments from central bankers that monetary easing will end soon have prompted outflows from the asset class.
Chris Iggo, chief investment officer fixed income at AXA Investment Managers, has just published an interesting and very readable note on the topic. He helpfully summarises its content in bullet point form as follows.
Computer says hike
- Reducing the balance sheet
- Guidance is tricky
- Risk is ongoing rate volatility
- High-yield could hold in
- Some buyers
- Transfer taxes
Past peak QE
“A macro strategist said to me this week that we are past the point of “peak QE” and if the overall stance of monetary policy is to move back towards that suggested by the Taylor Rule, then the bond market is in for further sell-offs,” he writes.
The Federal Reserve’s (Fed) balance sheet should start to be reduced later this year, the growth of the Bank of Japan’s balance sheet is slowing and most expect the European Central Bank (ECB) to begin tapering its purchases of bonds in 2018.
Global central bank balance sheet growth will slow and that means a net reduction in official purchases of bonds. The Taylor Rule estimates what the key policy interest rate should be at any point in time.
It is a similar story for the euro area with a Taylor Rule estimate suggesting that policy rates should be close to 2%, he continues. Take that with a pinch of salt but the message is clear that policy is too loose and the ECB needs to start winding down its own QE programme.
But the ECB does not say that
An examination of the minutes of the recent ECB monetary policy committee show, however, it does not say that. What they do say is that in particular, it was necessary to avoid signals that could trigger a premature tightening of financial conditions.
This in turn could put the progress made towards a sustained convergence towards the Governing Council’s inflation aim at risk, thereby prolonging the need for extraordinarily accommodative monetary policy.
The Governing Council decided to keep the interest rates on the Eurosystem’s main refinancing operations, the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and -0.40% respectively.
Rates to stay at present levels
The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.
Regarding non-standard monetary policy measures, the Governing Council confirmed that the net asset purchases, at the current monthly pace of €60bn, were intended to run until the end of December 2017, or beyond, if necessary.
And in any case until the Governing Council saw a sustained adjustment in the path of inflation consistent with its inflation aim. It is not quite the same as the headlines suggest. On the one hand, there are upsides to growth and inflation, the minutes say.
One thing is certain
On the other hand, the minutes say there are downsides to growth and inflation. Against this background (a recurring phase in the ECB MPC minutes) there is a clear temptation to make a remark which some will find unhelpful. One thing is certain, the outlook is unclear.
But it is...