U.S. Fed “tapering”: The basics in the FOMC’s own words

July 1, 2013

Envisaged Fed tapering is simply predicated on five principles: (a) balance sheet expansion will slow and ultimately cease if unemployment declines on a sustained basis to around 7%, (b) the pace of asset purchases remains data dependent, hinging on sustained labor market improvement and financial conditions, (c) tapering is not meant to tighten monetary conditions, (d) tapering does not per se lead to subsequent unwinding of Treasury holdings and may never result in MBS sales, and (e) tapering does not per se bring forward Fed fund rate hikes, which are subject to higher thresholds.

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What we can learn from Asia’s “tapering”

June 30, 2013

J.P. Morgan’s David Fernandez points out that central bank “tapering” (moderation of balance sheet expansion and related monetary accommodation, currently envisaged by the U.S. Federal reserve) has a precedent of sorts. Emerging Asia had ramped up central bank assets for a decade after the 1997-98 crisis, mainly though FX interventions to bolster financial stability and competitiveness. Asia has been unwinding part of that expansion, passively and in line with smaller external surpluses, since 2008. The initial balance sheet expansion did not undermine credibility and price stability. And the subsequent reduction may be interpreted as a positive normalization, reducing the risk of financial bubbles.

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Self-fulfilling tightening and recessions in a low interest rate world

June 23, 2013

A new Bank of England paper points to a dangerous pitfall for monetary policy in a low rates environment. “Speed-limit rules” stipulate that central banks adjust policies in accordance with the change in the economy (e.g. growth, the unemployment rate, or inflation), not its level, in order to avoid policy errors and anchor expectations. At the zero bound these rules can lead to self-fulfilling recessions, as a downshift in (growth and inflation) expectations triggers less hope for policy easing than fears for subsequent tightening (when the initial downshift is being reversed). In my view this dovetails recurrent fears of convexity or jump risk in low-yield bond markets, and may help explaining why global central banks at the zero bound have so far struggled to produce sustained recoveries.

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Quantitative easing and “VaR shocks”

May 19, 2013

Securities held by VaR (Value-at-Risk)-sensitive institutional investors, such as banks, are prone to escalatory selling pressure after an initial shock, in particular if they make up a substantial portion of the portfolio. Nikolaos Panigirtzoglou underscores that the Japanese government bond market has already demonstrated its proclivity to such ‘VaR shocks’. Also on a global scale government bond yields may overtime become more vulnerable, as one of the unintended consequences of quantitative easing.

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The effectiveness of non-conventional monetary policy

May 18, 2013

The latest IMF publications on non-conventional monetary policies affirm their effectiveness. This seems to hold true for all major forms, i.e. government bond purchases, forward guidance, and private asset purchases. However, bond purchases are likely to yield diminishing effects going forward. Their initial stimulus seems to owe much to the signalling of commitment and the repair of broken markets. Also, the economic impact seems to have a time limit. Meanwhile additional credible yield compression becomes ever more difficult as the zero boundary is drawing closer and central banks would struggle to extend commitments to ever longer durations.

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Historical precursor of Abenomics

May 13, 2013

Warwick professor Nicolas Crafts notes that the UK’s exit from recession and deflation in 1930s has similarities to Japan’s current expansionary policy. At the time the UK managed recovery and reflation through very low rates and initial currency devaluation. Crafts argues that such strategies may require abandoning inflation-targeting independent central banks.

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The impact of non-conventional monetary policy on financial markets

April 19, 2013

The April 2013 IMF Global Financial Stability Report takes stock of the market impact of non-conventional central bank policies. In particular, the latter have replaced traditional interbank and money market activity, turned the Fed into a dominant player in the U.S. MBS market, and made all G4 centrals banks (and particularly the Bank of England) a major holder of local government debt. The politically mandated biases in market prices could unwind disorderly if and when economic development mandates a reversal of non-conventional policies.

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Japan’s “Quantitative and Qualitative Easing”

April 14, 2013

On April 4 Bank of Japan Governor Haruhiko Kuroda unveiled aggressive “Quantitative and Qualitative Monetary Easing” (QQE), in order to meet a 2% inflation target within two years after 15 years of deflation. QQE means a shift of the operating targeting of the central bank to the monetary base, massive planned bond and other asset purchases, and a significant extension of duration in bond purchases. Market commentators almost uniformly concluded that QQE marks an extraordinary policy shift with historical dimensions and significant implication for global asset prices.

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Why and when “equity duration” matters

March 23, 2013

A new HSBC report suggests that if and when Quantitative Easing is being reversed it could be a watershed event for sectoral equity performance. Their view is based on the concept of “equity duration”. The long-standing outperformance of low-beta and high-quality stocks, which have longest duration and benefited most from three decades of falling yields, should come to an end and be replaced by relative strength of cyclical, financial and materials stocks.

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A Fed view on low long-term yields

March 9, 2013

Federal Reserve Chairman Bernanke recently explained globally low long-term yields as a combination of anchored inflation expectations, negative real policy rates, and a compressed term premium. The latter is seen as the key development since 2010 resulting from (i) the surge in private demand in the wake of reduced nominal volatility and negative correlation with risk markets and (ii) a surge in public demand resulting from asset purchase programs and FX reserves replenishing. Bernanke emphasizes that the Fed, markets, and forecasters all expect long-term yields to drift higher by 50-75bps per year through 2017. Yet, actually his reasoning would make a sustained directional change in yields contingent on fading crisis and deflation fears.

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