Central Banks Running Out of Ammo

March 17th, 2016 9:34 pm | by John Jansen |

This article reminded me of these couple of lines from a Yeats poem (on Saint Patrick’s Day) which I posted regularly at the height of the crisis in 2008 and 2009:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;

Via the WSJ:
By Min Zeng and
Ira Iosebashvili
Updated March 17, 2016 8:08 p.m. ET

Efforts by many of the world’s central banks to weaken their currencies are failing, raising concerns about whether policy makers are losing the ability to wield control over financial markets.

This was the case again in Japan on Thursday, when the dollar fell 1.1% against yen, to ¥111.39.

Despite the Bank of Japan ’s efforts to push down its currency and jump-start the economy with negative interest rates, the yen is up 8% this year and is at its strongest level against the dollar since October 2014. European central bankers are having similar problems containing the strength of the euro and other currencies.

These difficulties are a reminder that the long stretch of exceptionally low rates in response to the 2008 financial crisis has created market distortions that may be difficult for central bankers to contain.

This disconnect could produce more volatility in financial markets. Even if investors can predict what actions central banks are likely to take, they are having a hard time predicting how markets will react, potentially sparking a pullback from riskier assets, such as emerging markets or commodities.

It also underscores long-standing concerns about the prospects for global growth. A number of central bankers are reaching for the lever of lower interest rates to weaken their currency and make their exports more competitive. But because policy makers are all following the same approach, they are in effect canceling each other out.

“There is a rising concern that central banks are testing the limits of their policies,” said Brian Daingerfield, a currency strategist at RBS Securities. “Each time you take a tool out of the tool kit, it gets closer to being empty.”

The European Central Bank has struggled with its efforts to weaken the euro, which gained 0.8% against the dollar on Thursday. Last week, the ECB cut interest rates further into negative territory, yet the currency is up 4.2% this year.

Even some central banks with less actively traded currencies are having a hard time guiding markets. Norway’s central bank on Thursday cut its main interest rate to a record low of 0.5%, and a bank governor said he wouldn’t rule out negative rates, in which central banks charge big lenders to hold deposits. The Norwegian krone gained more than 1% against the dollar and was up against the euro.

Lower interest rates in the past have had the effect of making a currency less attractive to hold as investors seek out higher-yielding assets.

Unlike its peers, the Federal Reserve is still able to produce more predictable results. After the Fed left interest rates unchanged on Wednesday and Chairwoman Janet Yellen said the central bank wasn’t going to raise rates as swiftly as it had anticipated, the dollar fell against most major currencies, as expected.

It wasn’t that long ago that actions, or even the hint of future action, from most of the major central banks had a powerful effect on their currencies.

Japan Prime Minister Shinzo Abe promised unprecedented monetary easing upon taking office in late 2012, looking to kick-start growth and spur inflation. Mr. Abe’s handpicked head of the Bank of Japan flooded the economy with cash by kicking off a bond-buying program. The yen fell 37% against the dollar from October 2012 to June 2015.

Central bankers also used policy or moral suasion to strengthen their currencies. In 2012, Greece suffered the largest government debt default in history, leading many analysts to question the future of the European monetary union. ECB President Mario Draghi pledged to do “whatever it takes” to preserve the euro. His determination soothed investors and stopped the single currency’s tailspin, boosting it to an 11% gain against the buck in six months.

But as the long period of rock-bottom rates continued, that influence has looked like it is fading. While the ECB’s initial move to cut interest rates into negative territory in June 2014 sparked a sharp plunge in the euro, further cuts last December and last week have had little effect on the currency.

“The ECB’s hand has been played out,” said Alan Ruskin, head of G-10 foreign-exchange strategy at Deutsche Bank AG . “The currency market isn’t as responsive to the ECB anymore.”

Similarly, markets have ignored the Bank of Japan’s hints at its monetary-policy meeting this week of more rate cuts to come. Not only has the mechanism transmitting ultraloose policy into the real economy appeared to be broken, but some unconventional policy tools—such as negative interest rates—have been deleterious to banks and rattled financial markets.

“Banks get squeezed and savers are inadvertently encouraged to hoard cash or, worse, encourage bubbles by forcing money away from the safety of government debt and into other markets regardless of fundamentals,” said Anthony Cronin, Treasury bond trader at Société Générale SA .

A number of government bonds are yielding below zero in places like Japan, the eurozone and Switzerland. Money managers said this has added to concerns that central banks are distorting the normal market function and that investors are finding it difficult to fairly value financial assets.

Analysts said central banks need to pay attention to the unintended fallout on markets and banks from tools such as negative interest rates. Mr. Draghi signaled hesitance to cut rates deeper into negative territory this month, while Ms. Yellen said this week that Fed officials aren’t “actively considering negative rates.”

Still, some market participants warn it may be too early to judge whether central-bank policies are losing effectiveness.

Donald Ellenberger, head of multisector strategies at Federated Investors, which had $350 billion in assets under management at the end of December, said central banks “have proven remarkably creative devising ways to use monetary policy to try to stimulate the economy.”

He cited the latest stimulus from the ECB on March 10, with the central bank adding nonfinancial corporate debt to their bond-buying list. The move has fueled a rally in corporate bonds and sent yields falling, which helps lower corporate borrowing cost.

“Central banks are experimenting in real time,” he said. “There is no lab for them to practice in.”

 

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