Events last night brought me back to my first entry into the blogging world as the actions of Ben Bernanke and the US Federal Reserve reminded me of it. Back on the 13th of November 2009 I pointed out this about Quantitative Easing.
Also I have heard no coherent policy on how this policy is going to be reversed
This concept was fairly quickly labelled under the category of exit strategies and to my mind a successful policy action required you to be as sure how you would reverse it as how you would start it. However it was and indeed still is my opinion that thoughts and plans about exiting QE were left for another day, presumably being hidden in any recovery then taking place. There has been a marked shortage of official pronouncements pointing out that it was another action designed to borrow from the future. After all that might lead to minds wondering about the consequences of the future not being as “bright” as the picture invariably painted by official forecasts.
Rather ironically the departing Bank of England Governor Mervyn King introduced elements of such a line of thought at his Mansion House speech last night.
The present extraordinary monetary policies cannot, however, continue indefinitely
Although as ever there is a contradiction between his words and his deeds as if we look at the latest Monetary Policy Committee minutes we see this.
Three members of the Committee (the Governor, Paul Fisher and David Miles) voted against the proposition, preferring to increase the size of the asset purchase programme by a further £25 billion to a total of £400 billion.
Yes Mervyn King had just done his best to keep it going indefinitely!
Asset Price Bubbles
Back on January 10th 2010 I pointed out this as I discussed what was a dilemma for central bankers.
The sums spent have contributed to the rise in asset prices such as stock markets and commodity prices. It may have contributed to an asset price bubble here. I would remind you that part of its role is to help control and avoid bubbles not create them.
This theme developed two strands. The first was that we saw asset and commodity price bubbles develop in many places. The second was that central bankers increasingly took credit for rises in equity markets. The latest version of QE in Japan called Abenomics has taken this unhealthy development even further as it seems to regard the level of the Japanese equity market (Nikkei 225) as a policy tool in itself. Both of these were dangerous and the latter in particular fed into the concept of this being a junkie style culture with the central banks operating as a type of dealer/supplier. This leads us to the issue of withdrawal symptoms and maybe even cold turkey depending on circumstances.
The US Federal Reserve
The latest meeting statement was released last night and it would be an understatement to say that it was eagerly awaited. Here are the relevant excerpts.
The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.
When the Committee decides to begin to remove policy accommodation
These hints were backed up by stronger economic forecasts which as I will discuss later impacted strongly on financial markets immediately.
In the press conference the current Chairman of the US Federal Reserve kindly defined what tapering meant to him.
If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.
So we see that he is publicly admitting to contemplating a reduction in the current US 85 billion of QE purchases per month. Indeed he then went further.
And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.
So around the middle of 2014 the policy could be stopped. There is a get-out clause in that this will depend on changes in the US unemployment rate as the objective is for it to decline to 6.5%. As an aside I still think that they made an error here as it would have been more logical to target the employment rate.
An Exit Strategy At Last?
I am reminded of the words of Winston Churchill after the battle of El Alamein in 1942.
Now this is not the end. It is not even the beginning of the end. but it is, perhaps, the end of the beginning.
Because if we review what has taken place we see that rather than an exit strategy we are seeing only the probability of a reduction in purchases accompanied by the possibility of an end to QE purchases. There are no plans for any sales of the mortgage and government bonds purchased. Perhaps of course the intention is in fact not to sell them and let them mature and kick the can of dealing with the monetary expansion forwards to another yet unspecified day. Currently according to the St. Louis Fed this amounts to 1,906 billion US Dollars (and rising).
So at best this is a passive type of exit strategy that in effect hopes that the problems created will melt away over time. The history of the credit crunch would lead even the casual observer to decide that this was unlikely and I am of the view that there will be problems. Exactly how many depends on events.
Speaking of events
Whilst the media is concentrating on equity market falls which have continued this morning – The UK FTSE 100 has dropped 2% to 6222 as I type this- the more significant impact was felt elsewhere.
US Treasury Bond prices fell heavily and yields surged in response to the news. The ten-year benchmark yield has reached 2.4% now which is up from more like 1.6% at the beginning of May. This has been something of a rout in bond markets which has spread to UK Gilts (government bonds) as our market has dropped to 2013 lows as our ten-year yield has risen to 2.28%. Furthermore interest-rate expectations have changed in futures markets ( confusingly called short sterling) and they are now pricing in the prospect of a rise.
We will have to see if markets are overshooting in the short-term but bond markets changed course a month and a half ago and longer-term interest rates have risen. In the United States this has raised mortgage rates for example with the thirty-year hitting 4.17%. The impact in the UK is slower and of course will clash with the Funding for Lending Scheme which is trying to drive lending higher and mortgage rates lower.
For those unaware of the name, Jon Hilsenrath is an economics reporter at the Wall Street Journal who is widely considered to be a mouthpiece for the US Federal Reserve. At the end of last week I was very critical on twitter of the way that the Federal Reserve appeared to be using him again to conduct monetary policy by newspaper articles. I guess now I will at least be joined by those who thought it was safe to return to bond markets.
The world has moved into a new phase of the credit crunch where the central bank of its reserve currency has begun to talk of reducing its previous “More,More,More” strategy. So far it is just talk and as I have pointed out earlier we are currently only facing a reduction in the rate of QE expansion as opposed to an end to it or a reversal. But in the junkie style culture that has been developed by it we are already seeing one or two signs of indigestion and an amber light or two.
The rise in bond yields we have seen may well be opening a new front in the analysis of QE. For example the Bank of England tells us that one of the ways that QE operates is via this.
That lowers longer-term borrowing costs
As you can see they are now rising. Some care is needed as they fell by much more than the recent rise but we perhaps are getting an insight into QE which is aligned with something I have long suspected. If it is to have an effect on bond yields and keep them (ultra) low it looks as though “More,More,More” will be required. On that road there is no possible exit strategy without interest-rates bouncing back strongly. Will that reverse any nascent recovery and plunge us back into the gloom?