Central banks on road to nowhere?

There was quite a bit of economic data last week, and once again it was very mixed. While there were a few bright spots elsewhere, weak international trade numbers were reinforced by soft Chinese and U.S. Retail Sales figures. Yet, global equities markets did not seem to mind because a “bad news is good news” psychology means continued central bank accommodation. Along with occasional bright spots (like recent U.S. Employment reports), this keeps equities trending higher in spite of some of the U.S. and global headwinds.

Yet, the govvies also like the ‘bad’ news, and have held well on setbacks in spite of the elevated levels seen on their recent rallies (especially the Gilt.) On the other hand, the seeming anomaly has been the US dollar that has weakened in spite of the recent equities strength. Normally the U.S. equities leading the way higher would encourage strength in the greenback. Still, the serial weak U.S. economic data outside the bright spots have intrinsically weakened the US dollar in conjunction with the waning prospect of any Fed rate hike in this environment.

The latter has not only weakened the greenback against developed economy currencies, it has also fostered significant improvement of emerging currencies. That demonstrates the full scope of the US dollar weakness against everything other than the beleaguered British pound. The pound’s renewed weakness after its post-Brexit implosion rally is partially tied into the expectation that the Bank of England (BoE) will need to engage in further significant steps beyond its initial return to QE last week.

Carney doesn’t like negative rates

Even after cutting the base rate to just 0.25%, BoE Governor Carney has a strong aversion to zero interest rate policy (the ZIRP already in place at so many other central banks) Yet the seeming failure of the renewed asset purchase program (QE) just two days into the exercise due to long-dated Gilt holders’ unwillingness to sell represents a problem for pursing that avenue toward stimulating the UK economy. 

A very interesting Financial Times Weekend editorial on “The BoE ‘sledgehammer’ hits limits in the gilts market” opens with the idea that all of the BoE’s post-Brexit efforts may not change behavior. And that is a reasonable assertion in the context of the limited success of other QE programs. As we have noted on many occasions, central bank QE alone will not restore robust growth.

Headwinds trump QE

That FT Weekend editorial makes a couple of points that are actually intrinsic to all central bank QE results. It notes, “It is not clear that lower borrowing costs will prompt businesses to invest or individuals to spend in this situation.” The operative term there seems to be “in this situation.”

How is that so much different, for instance, than the United States, where extensive expansion of regulatory burdens on U.S. businesses has fomented the first instance since records began where more small businesses (the drivers of new employment creation) are closing than opening? The same goes for the EU and Japan, where bureaucrats seem to dream up new hurdles without any sensitivity to the real world costs to businesses and employment.

Smaller QE benefits

The further observation from the Financial Times this weekend is that even if the Bank of England can go further, “…like other central banks, it is nearing a point at which further stimulus will have smaller benefits and undesirable side effects.” Just look at how little further impact Japan’s major central bank rate cuts and government stimulus have had on an economy that just reported further abysmal GDP statistics. Even the U.S. home of massive QE has just seen its GDP weaken to a Q2 level that neutralizes the Q2 rebound hopes.

[As an aside to that general view, today’s weak U.S. CPI numbers have helped weaken the U.S. Dollar Index back below its .9550-00 over/under congestion to retest the post-Brexit .9460 UP Break out of its weekly down channel (from the early December 1.0050 high.)]

Yet the overall sense that the “situation” is not conducive to investment and hiring was emphasized in the FT weekend editorial note near the end that “…further stimulus measures may be counterproductive if they merely spur savers who want to guarantee a retirement income into squirreling away even more cash.” Isn’t central bank stimulus intended to foment just the opposite reaction?

Structural reform still the key

Yet in other countries as well we have seen the extremely low rates encourage more risky investment to achieve returns than any desire to spend more money in the real economy. Hence the strength of the equities in spite of problematic economic data, and the continued strength of the government bond markets. The conclusion of the FT weekend editorial sums it up: “This is not a dilemma that central banks can resolve. If the UK economy needs further support, the onus will be on the government.”

No kidding! This need for structural reform to support central bank efforts has been our view since early 2015, and it remains the same today.

Back to that reference to the “situation,” we noted in January 2015’s www.rohr-blog.com post "It’s Lack of Reform, Stupid!" (Parts 1 & 2 on the Jan. 19 and 24) that the lack of structural reform from the political class would ultimately undermine any of the productive cyclical recovery tendencies reinforced by the central bank efforts. And there have more so been more regulatory and taxation headwinds that any sort of reform.

Euro-zone banks hoarding cash

While there is no "crisis" at present, there is still the potential for real disappointment at some point if all of the central bank efforts are seen to not have the desired effect. At present the negative rates in the Euro-zone are leaving the commercial banks considering storing cash in high security vaults to avoid the negative rates on central bank deposit facilities. This could be considered bizarre activity if it were not commercially viable.

And it also points out the degree to which the central banks’ efforts to force banks to lend where there is no real loan demand are perverse steps. This could only be happening in an environment where businesses see no point in capital investment and hiring. As the end of the FT editorial noted, “the onus will be on government.” However, it has already been on governments for years, with no indication highly partisan factions are willing to even consider structural reform.

The next crisis

We stick with our Futuresmag.com Feb. 11 “Market fear and loathing” observation: The next financial crisis will occur when the investment and portfolio management community (and ultimately the investing public) realizes that the central banks alone cannot restore the robust growth from prior to the 2008-2009 financial crisis. In the current environment that might be fomented by a political crisis. The backlash that led to the UK LEAVE vote is also apparent elsewhere. And in the United States the Presidential election alternatives are not economically propitious on either side.

End of the line

What all of this illustrates is a political class that is so partisan as to be incapable of reasonable, collegial structural reforms. And as the central banks are obviously near the (very distended) end of the line on interest rate and monetary accommodation, the full impact of all the previous lack of structural reform may become more apparent in sustained economic weakness sooner than not. There is a chance that all of the central bank efforts will have been nothing more than a long trip down the “road to nowhere.”


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