There's a 'gathering storm' in the global economy and central banks are running out of options
7
March, 2016
The
Bank for International Settlements (BIS) — known as the central
banks' central bank — is warning there's a "gathering storm"
in the global economy, in part caused by governments around the world
running out of monetary policy options.
In
two separate notes, published March 6, BIS economists highlighted the
fragile global economic backdrop and said negative interest rates
could become a reality for many more countries as central banks
search for ways to stoke real growth and battle issues like tumbling
oil prices hitting the economy.
"The
tension between the markets’ tranquility and the underlying
economic vulnerabilities had to be resolved at some point,"
said BIS
chief Claudio Borio.
"In the recent quarter, we may have been witnessing the
beginning of its resolution."
"We
may not be seeing isolated bolts from the blue, but the signs of a
gathering storm that has been building for a long time."
In
a report entitled "Uneasy calm gives way to
turbulence," Borio warns
that 2016 is off to a terrible start and it's really freaking out the
central banks (emphasis ours):
The
Federal Reserve's interest rate lift-off in December did little to
disturb the uneasy calm that had reigned in financial markets in late
2015. But
the new year had a turbulent start, featuring one of the worst stock
market sell-offs since the financial crisis of 2008.
At
first, markets focused on slowing growth in China
and vulnerabilities in emerging market economies (EMEs) more broadly.
Increased anxiety about global growth drove the price of oil and EME
exchange rates sharply
lower and fed a flight to safety into core bond markets. The
turbulence spilled over to advanced economies (AEs), as flattening
yield curves and widening credit spreads made investors ponder
recessionary scenarios.
In
a second phase, the
deteriorating global backdrop and central bank actions nurtured
market expectations of further reductions in interest rates and
fuelled concerns over bank profitability.
In late January, the Bank of Japan (BoJ) surprised markets with the
introduction of negative interest rates, after the ECB had announced
a possible review of its monetary policy stance and the Federal
Reserve issued stress test guidance allowing for negative interest
rates. On the back of poor bank earnings results, banks' equity
prices fell well below the broader market, especially in Japan and
the euro area. Credit spreads widened to a point where markets
fretted about a first-time cancellation of coupon payments on
contingent convertible bonds (CoCos) at major global banks.
Underlying
some of the turbulence was market participants' growing
concern over the dwindling options for policy support in the face of
the weakening growth outlook.
With fiscal space tight and structural policies largely dormant,
central bank measures were seen to be approaching their limits.
The
below chart from BIS neatly sums up just how bad 2016 is shaping up
to be for the global economy.
BIS
The
idea of "dwindling options" for central bankers is picked
up by BIS economists Morten
Linnemann Bech and Aytek
Malkhozov who
look at the effects of negative interest rate policies adopted by
central banks recently — once seen as unthinkable but now necessary
as the armory of monetary policy weapons gets sparser.
In
a separate review entitled "How have central banks implemented
negative policy rates?", the pair write that:
Since
mid-2014, four central banks in Europe have moved their policy rates
into negative territory
.
These
unconventional moves were by and large implemented within existing
operational frameworks. Yet the modalities of implementation have
important implications for the costs of holding central bank
reserves.
The
experience so far suggests that modestly negative policy rates
transmit through to money markets and other interest rates for the
most part in the same way that positive rates do. A key exception is
retail deposit rates, which have remained insulated so far, and some
mortgage rates, which have perversely increased. Looking ahead, there
is great uncertainty about the behaviour of individuals and
institutions if rates were to decline further into negative territory
or remain negative for a prolonged period.
Negative
interest rates are intended to encourage borrowing, discourage upward
pressure on currencies, and help trade.
A
handful of countries have already said goodbye to ZIRP (zero interest
rate policies) and hello to NIRP (negative interest rate policies).
The goal of negative rates is to deter institutions from storing cash
in banks and to flush that cash out into alternative investments,
spurring the economy, growth, and inflation.
BIS
However,
while the Swedish
government’s massive experiment with negative interest rates seems
to actually be doing what it’s supposed to,
according to the
Riksbank monthly inflation report,
which dropped on February 18, negative rates are having a much
broader impact around the world.
My
colleague Ben
Moshinsky pointed out in his analysis,
"evidence that negative interest rates aren't working to
stimulate global growth is getting hard to ignore."
Bank
of England Governor Mark
Carney warned at a G20 meeting in Shanghai that,
while negative rates might be an attractive way for an individual
country to weaken their currency and boost exports, the world economy
will suffer as a whole.
They
help to push economic activity around the globe, but do nothing to
boost it
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