The world’s central banks appear to be in a serious quandary. Interest margins are tumbling even though the European Central Bank, U.S. Federal Reserve, Bank of Japan, and Bank of England are keeping their policy rates low. And while central banks are working to boost liquidity, they can’t impact bank lending much, note Morgan Stanley analysts and economists.
Central banks deploy various tools
Morgan Stanley put together some excellent graphs and commentary from its various economists and strategists. Elga Bartsch, the firm’s chief European economist, outlined the various tools central banks use in their attempts to boost their economies. Forward guidance (a.k.a. communication) isn’t on here as it’s the most basic of the strategies, but here’s a nice summaries of the big guns and which central banks are using which ones:
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She also notes that although policymakers are trying to boost interest margins, their low policy rates are failing to do it:
And then there’s the issue of liquidity and its relation to bank lending. Central banks aren’t helping here either:
The Fed’s not talking…
Ellen Zentner, Morgan Stanley’s chief U.S. economist, pointed to comments made recently by Janet Yellen, chair of the U.S. Federal Reserve, as indicators of just how tight-lipped the U.S. central bank is being. While earlier the Fed indicated that it was considering negative rates, Yellen said they’re not “actively” considering them as they seem to be having mixed effects in other countries. She also spoke on alternative tools, and Zentner quotes her thus:
“… If we found ourselves in the unlikely situation where we needed to add accommodation… we have a range of tools and we know from things we did in the past that we have a number of options… The maturity, for example, of our portfolio with respect to asset purchases or forward guidance that remain available to us are tools we could turn to in the unlikely event that we need to add accommodation.”
… But forward guidance is needed
The fact that she brings up forward guidance is very interesting as last week’s Fed press conference brought no indication about which direction U.S. policymakers are leaning in on the topic of a rate hike in June. It seems the markets interpreted this lack of forward guidance on this issue to mean that there won’t be a hike in June, but economists tend to think that there will indeed be one.
Zentner said that “simulations of a negative aggregate demand shock and positive shock to risk premia under different monetary policy responses suggest enhanced forward guidance helps generate faster recovery.”
What can we expect?
The Morgan Stanley team expect the European Central Bank and Bank of Japan to ease further through more rate cuts even though thus far they have had limited success in boosting bank lending. They expect the U.S. Federal Reserve to shift its communication policy if a downturn in data should occur.
Because of the strong policy divergence we’re seeing between the U.S. and other major central banks, they don’t think the U.S. dollar bull market is over. The Fed’s more dovish tone suggests that real yields will be lower and inflation will be higher, they add. Further, they expect the ECB’s action to result in cheaper U.S. credit and favor non-financials over financials.