Sulk but no tantrum likely as central banks sidle toward exit

LONDON: History suggests that financial markets react violently when a central bank signals it is scaling back the stimulus that has kept an economy afloat – and lined the pockets of investors.

Now the world’s three leading central banks, to varying degrees, are edging toward an end to ultraeasy monetary policies which have inflated the value of financial assets, and yet investors seem largely unruffled.

Policymakers appear to be learning the lesson of 2013, when former Federal Reserve President Ben Bernanke suggested the US central bank might slow or ‘taper’ the expansion of its balance sheet.

The thought that the Fed would reduce the heavy bond purchases and other policy schemes it had used to flood the banking system with cash since the global financial crisis provoked the ‘taper tantrum’.

That knocked nearly 7 per cent off US stocks, sent Treasury yields climbing more than 100 basis points, and sowed turmoil in world markets from Rio de Janeiro to Jakarta.

Four years on, the Fed is talking about trimming its balance sheet, rather than merely slowing its growth, and at the same time the European Central Bank and even the Bank of Japan are cautiously looking to the end of monetary easing.

Investors seem confident that policymakers can get their message over without too much drama. Financial markets are expected to sail through a couple of policy meetings this month that could in years to come be seen as the beginning of the end of extraordinary central bank support.

“It might be the beginning of a drip feed of how it’s going to happen,” said Tim Graf, head of macro strategy for EMEA at State Street.

“The experience of the taper tantrum will guide thinking about that. They don’t need to be aggressive. They don’t need to be dogmatic. They can be very gradualist and prepare markets.”

ECB policymakers will discuss closing the door to extra stimulus when they meet on June 8, sources told Reuters, while most economists expect it to signal by September a scaling back of its asset-purchase scheme.

On June 14, Fed chief Janet Yellen is set to be quizzed on its plans to cut massive asset piles later this year, as revealed in minutes of its last meeting.

Even the BOJ, which has failed to come close to pushing inflation up to its target despite four years of money printing, is having closed-door discussions about an exit strategy.

Highly telegraphed

Investors are prepared for signs of retreat, even though arguably there is more at stake for markets than there was in 2013: these three central banks together hold over US$13 trillion in assets, a third more than four years ago, according to Reuters data.

“Back then taper wasn’t really a word that everybody used in the context of monetary policy and Bernanke spat it out and markets reacted in a shocked way,” said Andrew Bosomworth, a senior portfolio manager at one of the world’s biggest bond funds, PIMCO.

“Now this is widely discussed and highly telegraphed, so I don’t think it will lead to that kind of reaction.”

When Bernanke spoke the fateful word on May 22, 2013 it came out of nowhere. On the same day, minutes from the Fed’s meeting showed dealers expected the central bank to hold purchases at the same pace until December.

Bosomworth and others argue that a slow and cautious withdrawal by central banks has put investors at ease.

Fed officials say any trimming of the balance sheet, which has ballooned to near US$4.5 trillion, could take three to four years. The final level will remain substantially above the US$800 billion level of before the crisis, they say.

The ECB, while it did not call it tapering, slowed its monthly bond purchases when it extended its scheme in April, and has been scaling back buying the debt of certain euro zone governments where it is approaching limits.

The BOJ has the tricky balancing act of trying to convince people it has a credible exit strategy without giving too much away.

Positioning

A tentative approach by all three central banks has given investors time to prepare for a future withdrawal and avoid a scramble when the moment eventually comes.

As an example of this, speculative positioning on US money markets – the biggest and most sensitive market tied to Fed policy – has fallen to a record short in recent weeks as investors anticipate tighter monetary conditions. Before the taper tantrum, it was at a six-month long.

In Europe, three quarters of economists polled by Reuters expect the ECB to signal it is scaling back monthly asset purchases by September, with six of those expecting the bank to move as early as this month.

But separate polls of bond market specialists suggest German Bund yields, the euro zone’s benchmark, won’t even be 30 basis points higher by October.

Investors say greater confidence in the health of the global economy is also helping to calm nerves. The IMF forecasts advanced economies will grow at around 2 per cent this year, compared with 1.3 per cent in 2013.

“The reaction we had to the Fed’s taper was extreme because there was still a question mark over the economy,” said Jim D’Arcy, fixed interest asset manager at Davy Asset Management. “I don’t think we will see a taper tantrum in Europe. We might see a warranted rise in yields, but nothing too dramatic.”

Complications

But the Fed has not been alone in making policy missteps. The Bank of England is now in a wait-and-see mode, but has been wrong-footed a couple of times in conveying its policy plans.

After Mark Carney became governor in 2013, he tried to show investors that rates would not rise for a long time, saying the Bank would not think about an upward move until unemployment fell to 7 per cent. The jobless rate suddenly plunged below that level, forcing Carney to find new guidance. — Reuters