Published April 12, 2013
From Washington and Brussels to Tokyo and Zurich, central bankers around the world have united to take extraordinarily aggressive action aimed at boosting demand for risky assets, staving off financial collapses and encouraging full employment.
While economists and investors hotly debate the merits and side effects of these efforts, there is little doubt the role of central bankers in the financial markets has never been greater.
“Never in human history have so many of them been so obsessed with their ‘mandates’ all at the same time. Central bankers have gone wild,” Ed Yardeni, president of investment advisory Yardeni Research, wrote in a note to clients this week.
Nowhere is that more clear than right here in the U.S. as the Federal Reserve’s balance sheet has swelled to $3 trillion through Ben Bernanke’s controversial quantitative easing program, which has helped drive equities to all-time highs.
“Interest rates are so low that it forces people to search for yield. It ripples throughout the economy,” said Jim Rickards, a partner at New York hedge fund JAC Capital Advisors. “I have a difficult time thinking of a market not manipulated by central banks at this point.”
While the major industrialized central banks have all taken aggressive actions in recent years that have had dramatic impacts on global markets, their end-goals have varied greatly.
“The major central banks of the world remain committed to doing whatever it takes to avert a Lehman-style financial meltdown in Europe, to lower the unemployment rate in the U.S., to stop deflation in Japan, to offset fiscal austerity in the U.K., to put a lid on the Swiss franc in Switzerland and to manage a slow appreciation of the yuan in China,” said Yardeni.
As the chairman of the world’s most powerful central bank, Bernanke has led the march on the monetary-policy front.
Fearing an economic depression, Bernanke slashed rates to record lows and then launched three versions of bond-buying plans aimed at the Fed’s mandate to encourage full employment.
While some believed the Fed may be ready to slow its monthly purchases of $85 billion in securities amid concerns of unintended side effects, Goldman Sachs (GS) told investors recent signs of an economic slowdown should “put a stop to the tapering discussion” for now.
Last week the Bank of Japan doubled down on QE, revealing plans to ramp up its purchase of government bonds to $75.5 billion a month in an effort to end 15 years of deflation.
“The BOJ is so obsessed with its domestic mandate that the consequences of its actions around the world are of no concern at all,” Yardeni said.
The European Central Bank has been nearly as aggressive, but without actually expanding its balance sheet. ECB President Mario Draghi’s 2012 promise to do “whatever it takes” to hold the eurozone intact has been credited with calming the continent’s crisis.
All of this coordinated action by central bankers marks a new chapter in monetary policy.
Rickards, author of Currency Wars, said that while there were coordinated moves by G7 countries in the 1970s and 1980s, those agreements were largely focused on exchange rates, not monetary policy.
“I do think this is unprecedented in history,” said Rickards.
Asset Bubble Buzz
Even though this is uncharted water for central bankers, it does appear that their moves are having at least some of the intended results.
The S&P 500 has surged 135% since the March 2009 bottom, while U.S home prices have continued to rebound. Although partially boosted by a drop in workforce participation, the unemployment rate has tumbled to 7.7%.
While the world’s 26 developed markets have rallied about 7% this year, they would be up just 1.63% without the U.S. and Japan, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
The eurozone has been able to hold onto all 17 of its members -- even Cyprus and its outsized banking system. In a boost to Japanese exports, the yen has tumbled nearly 29% since hitting 52-week highs in September, including about 6% this month alone. Japanese 10-year bond yields have retreated to just 0.50%, the lowest level since June 2003.
But are these financial metrics reflecting fundamental improvements that are here to stay or just fleeting central-bank magic? Not surprisingly, this question is a divisive one.
“All you’re getting is asset bubbles -- and they will pop,” said Rickards. He said stocks may continue to rise for the rest of the year, but “they’re going up because the Fed is printing money and suppressing alternatives such as savings.”
Others believe talk of a Fed-inflated bubble in equities is overblown, especially considering 129% surge in trailing S&P 500 earnings per share since market bottom, which nearly matches the market’s rise.
“It’s not like we’re operating in a bubble. Earnings and fundamentals have supported the move in the markets,” said Peter Kenny, managing director at Knight Capital Group.
Kenny said “it would be one thing if “the S&P 500 were trading at 25 times earnings. Instead, the S&P 500’s forward price-to-earnings ratio is at a far more reasonable 14.3. “That’s not an aberration,” he said.
Of course, there may be unintended consequences to the aggressive actions by central bankers, even if a bubble in stock prices fails to emerge.
Critics of the Fed worry about triggering a scary bout of inflation and argue that cheap bond yields have eased pressure on Washington to get the country’s fiscal house in order.
“There’s always a concern that the Federal Reserve will be a bit tardy in recognizing the need for a transition into a policy,” said Kenny. “There is precedent for that.”
Low interest rates during Alan Greenspan’s tenure at the Fed have been blamed for helping to inflate the credit and housing bubbles that led to the crash of 2008.
Bernanke has sought to assure the markets the Fed has the tools and willingness to enact an exit strategy and recently even some policymakers have openly talked about the increased costs of continuing QE.
“At what point do the metrics they use to justify QE change enough for central banks around the world to step away from the liquidity pump?” said Kenny. “What’s encouraging to me is we’re hearing different regional Fed governors speak to the need of scaling back of liquidity.”