In this article, we are going to review the policy stances of the major global central banks along with the trends which can help you predict their future actions. How much impact you think central banks have on the market determines how much weighting you give monetary policy when making an investment decision. However, what is undeniably certain is that central banks have an impact on the market. This makes the decision to review their policies an obvious one. We won’t tell you how to utilize our monetary policy analysis in your investing process, but this information still should be valuable to you as a framework for analyzing past trends and future probabilities. Even if you aren’t an investor of equity, debt, real estate, or other financial instruments, monetary policy still affects the currency that you use daily.
While terminology governments use to describe their tools and processes may be new, their tricks are as old as government itself. As Ben Bernanke, the former Federal Reserve chairman stated, we are undergoing a “great monetary experiment”, which began following the 2008 financial crisis. What makes this monetary experiment different from previous ones in history is the scope of coordinated worldwide monetary policy. As a general rule, when the government is getting creative, it’s time to get nervous.
All the global central bank policies are listed in the table below created by Pension Partners.
19 out of 23 central banks cut rates the last time they met. The monetary policies are even more dovish than what meets the eye. The data is skewed in favor of the number of countries hiking because the Eurozone makes up many large economies. That’s because there was economic weakness in 2015-2016. There wasn’t a full blown global recession, but there was enough weakness to catalyze the 2017 dovishness which has eased financial conditions and spurred global trade growth.
That column isn’t the biggest takeaway from this chart. The most interesting issue is that most central banks have negative real rates. Real rates are the interest rates the central bank sets minus the inflation change on a year over year basis. Often, we look at the Taylor Rule to determine whether the Fed is too easy or too tight in its monetary policy. That’s a complex analysis which involves a formula with many variables. We don’t have a Taylor Rule for every country, so the CPI growth is the next best thing. Every single developed economy has negative real rates. This isn’t a problem centered around the US; it’s a global issue. Eventually, these central bankers will be reversing these easy policies; this could reverse the growth seen in 2017.
When we tell someone, who isn’t an investor, to pay attention to monetary policy it’s a tough sell. There needs to be shocking statistics which bring light to the situation. It’s like when the majority of the population only watches the weather when there’s a big storm coming. We’re not saying catastrophic results will necessarily occur, but watching the events closely is a good idea, unless you don’t care about your future. One of the shocking stats is seen in the Deutsche Bank chart below.
The Bank of Japan (BoJ) holds 50% of all the Japanese government bonds outstanding, making Japan’s monetary policy of quantitative easing the most ludicrous in the entire world. In an effort to monetize the debt, the Japanese government is effectively nationalizing the entire Japanese market. Which brings us to the next point – the Japanese debt market isn’t a market at all because the government controls it through its outsized purchases and influence. This bond buying has turned normal low risk securities into trading vehicles as speculators try to front-run the momentum in an endless bid for financial products, creating a self fulfilling prophecy, and with it moral hazard. 10 years ago, this possibility was unthinkable, but now it’s rational to say the BoJ will run out of its own government bonds to buy. If the BoJ decided to sell the bonds, it would cause interest rates to spike higher.
The chart below does a great job of looking at the historical size of central banks’ government bond ownership.
The Citi chart above breaks down the various countries’ central banks’ share of government debt held as a percentage of general government debt, government securities, and GDP. The most shocking aspect of this chart is once again Japan as the BoJ’s balance sheet is 79% of GDP. The BoJ hasn’t stopped at government bonds as it also owns ETFs. At this pace, the BoJ will own every single asset in the country. You can look at this as a proxy for the spreading of socialism with an end goal being communism, which is government ownership of businesses. This could become a political issue. In some sense, it already has because the central bank owning stocks has brought about a morale hazard as some companies aren’t seeing their stock valuations reflect their business’ performance because too much of it is owned by the BoJ which won’t sell if/when there is poor corporate performance.
Yields are the lowest in decades. The issue is what will happen next. If the ECB reverses this policy, the yields will rise and many of the companies which relied on low yields will fail. If the EU continues to keep rates low, then there will be further accelerated risk taking where speculators search for high yield in risky asset classes. Does the ECB bail out risky behavior when it ends in despair? The problem is capitalism can’t function properly when there’s no cost of capital and when interest rates are engineered artificially by authorities.
We’ve previously looked at the Swiss National Bank’s stock buying program which revealed it owned a lot of Apple shares. This means the SNB is helping Apple at the expense of smaller competitors. We can see more unequal behavior in the Citi chart below.
The ECB owns more Netherlands bonds than Italian bonds. Italy can’t complain because the ECB supports its banking system which is in shambles. The issue is that this bond buying might be furthering the divide between the risky countries and the safer countries.
We previously discussed the risk of the BoJ running out of stocks and government bonds to buy. That’s also a problem in Europe. As you can see from the Citi chart, there isn’t much remaining German government bonds left to buy. This highlights the two risks facing this policy. Either the ECB will run out of bonds to buy or it will stop buying on its own accord. Either change means a reversal in the stimulative policy, and with it asset prices.
Hopefully these charts helped you see the size of the problem central banks worldwide have gotten themselves into, buying too many assets in an attempt to stimulate the economy. The balance sheet unwind central banks say they will begin in 2018-2019 could disrupt the financial markets.
No matter how much central banks try to influence markets, they cannot prevent the business cycle from experiencing normal ups and downs. Nothing moves in a straight line indefinitely. At the end of the day, once these “great monetary experiments” are concluded, the victim will always be the currency. Unless you own money.