The Bank for International Settlements – i.e., the “central bank for central banks” – released its quarterly outlook on Sunday. As usual, it’s chock-full on quotables starting with the opening remarks by Claudio Borio.
It comes as no surprise that Borio – head of the BIS monetary and economic department – reiterates calls for fiscal policy to do more when it comes to staving off a global downturn. One year ago Monday, he conjured the familiar drug addition parallel in the course of discussing the mini-meltdown in emerging markets that unfolded in the summer of 2018.
“The highly unbalanced post-GFC recovery has overburdened central banks”, he warned, adding the following color:
The powerful medicine of unusually and persistently low interest rates has served to boost economic activity, but some side effects were inevitable. The financial vulnerabilities that we now see are, to some extent, one such example. The market ructions are akin to a patient’s withdrawal symptoms.
Again, that was in reference to the tumult unfolding in EMs at the time, as the Fed continued to tighten, the dollar strengthened and trade war began to escalate in earnest.
“With interest rates still unusually low and central banks’ balance sheets still bloated as never before, there is little left in the medicine chest to nurse the patient back to health or care for him in case of a relapse”, Borio warned, adding that “the political and social backlash against globalisation and multilateralism adds to the fever”.
The day after those remarks were published (i.e., on September 24, 2018), 10% tariffs on $250 billion in Chinese goods went into effect. The following week, Jerome Powell uttered the phrase “long way from neutral”. The rest is history.
Now, here we are a year later, and central banks are in the process of plunging back down the accommodation rabbit hole.
With rates just barely off the lower bound at “best” and still mired in NIRP at “worst”, and with balance sheets still as bloated as before (and on their way to getting more so with the re-launch of ECB QE and the imminent “organic” growing of the Fed’s balance sheet), there’s little to suggest that the burden won’t once again be placed almost solely on monetary policy.
“The monetary policy normalisation process has reversed: policy rates have started to decline again and central bank balance sheets to grow, in aggregate”, Borio said, in remarks published Sunday, adding that with “the room for monetary policy manoeuvre narrow[ing] further, should a downturn materialise, monetary policy will need a helping hand, not least from a wise use of fiscal policy in those countries where there is still room for manoeuvre”.
That echoes Mario Draghi’s call for politicians to step up, and there’s no question that some of the impatience is aimed squarely at Germany.
Borio also delivers some zingers on negative rates.
“A growing number of investors are paying for the privilege of parting with their money. Even at the height of the Great Financial Crisis of 2007-09, this would have been unthinkable”, he chides, before musing that “There is something vaguely troubling when the unthinkable becomes routine”.
Find his full opening remarks to the BIS’s quarterly report below.
Via the BIS
Markets oscillated. Trade tensions pushed them down; monetary policy propelled them up. But as this push-pull game went on, one asset price had only one direction to go: bond yields continued their downward glide, reaching a new nadir.
If the March Quarterly Review told a tale of two halves, this one tells a tale of two forces. Over the past three months, trade tensions between the United States and China loomed large, but other countries, such as Mexico, did not escape new tariff threats. As in the past, signs of an escalation in the trade skirmishes hit risky asset prices hard, dragging equity prices down and pushing corporate bond spreads up. And as central banks eased pre-emptively in response to the darkening economic outlook and tighter financial conditions, risky asset prices rebounded while inflation remained stubbornly low.
Against this backdrop, sovereign bond yields naturally declined further, at times driven by the prospect of slower economic activity and heightened risks, at others by central banks’ reassuring easing measures. At one point, before the recent uptick in yields, the amount of sovereign and even corporate bonds trading at negative rates hit a new record, over USD 17 trillion according to certain estimates, equivalent to roughly 20% of world GDP. Indeed, some households, too, could borrow at negative rates. A growing number of investors are paying for the privilege of parting with their money. Even at the height of the Great Financial Crisis (GFC) of 2007-09, this would have been unthinkable. There is something vaguely troubling when the unthinkable becomes routine.
Naturally, much of the financial market action had the United States as its epicentre. Still, given the global scale of trade concerns, US financial markets’ size and the US dollar’s international reach, much of the world gyrated too. Central banks eased policy in advanced and emerging market economies (EMEs) alike. The latest one to join in was the ECB, which eased in a multi-pronged way, combining a cut in the policy rate further into negative territory, an extension of forward guidance – now linked to the attainment of the inflation objective – a resumption of asset purchases, and more generous terms on special financing for banks.
Exchange rates could not remain immune to the confluence of trade tensions and monetary policy responses. EME currencies depreciated most against the US dollar, not least following a weakening of the renminbi to below the psychological threshold of 7 to the dollar. But the greenback remained broadly stable against advanced economy currencies, in part owing to actual or anticipated monetary policy easing there – sterling’s depreciation being an obvious exception. The exchange rate-monetary policy nexus became part of the trade rhetoric, threatening further tensions.
As the global economy weakened, financial market participants once again turned their attention to the inversion of the yield curve: long-term rates falling below short-term ones. This closely watched indicator of a future recession, in turn, fuelled financial market concerns, arguably pushing long-term rates down and inverting the curve further. In contrast to the past, however, the inversion reflects a historically low term premium – in part driven by central banks’ asset purchases. The premium has not shown similar leading recession indicator properties. Indeed, as we explain in a box, there are reasons to be very cautious when interpreting the yield curve signals, not least as the Federal Reserve has been easing rather than tightening. Other indicators paint a less pessimistic picture.
That said, the credit standing of non-financial corporations in general, and the surge in leveraged loans in particular, represent a clear vulnerability. On the back of aggressive risk-taking and a search for yield, a growing portion of these bank loans to highly indebted firms have become the raw material for structured securitisations, known as collateralised loan obligations (CLOs). There are close parallels with the infamous collateralised debt obligations (CDOs), which resecuritised largely subprime mortgage-backed securities and played a central role during the GFC. A box examines similarities and differences between the two types of instrument and the broader market ecosystem. It concludes that while the picture offers less cause for concern, financial distress cannot be entirely ruled out, especially in the light of the concentration of some known bank exposures, uncertainties about the size and distribution of indirect ones, and the surge in market finance post-crisis. Moreover, losses on these asset classes, and leveraged loans more generally, are likely to amplify any economic slowdown.
Where does all this leave financial markets and policy? Despite the financial markets’ ups and downs and concerns about a further global slowdown, financial conditions remain quite easy from a historical perspective. Corporate spreads are rather low and equity valuations rather rich. Economic conditions have been weakening, but so far at the global level a much larger and stronger services sector has contained the blow inflicted by a sharp slowdown in manufacturing. Inflation has generally remained stubbornly low. Above all, the monetary policy normalisation process has reversed: policy rates have started to decline again and central bank balance sheets to grow, in aggregate. The room for monetary policy manoeuvre has narrowed further. Should a downturn materialise, monetary policy will need a helping hand, not least from a wise use of fiscal policy in those countries where there is still room for manoeuvre.