Earlier this week, the Japanese government nominated Seiji Adachi to the board of the Bank of Japan. The news made few waves outside Japan, since Mr Adachi is little known.
However, global investors should pay attention. Mr Adachi is a renowned “reflationist” who favours massive monetary expansion. So his selection suggests that after two decades of eye-poppingly loose monetary policy, the BoJ is set to double down in 2020.
That is remarkable. Moreover, Japan is not alone. This week the Federal Reserve left US rates unchanged, after three cuts last year. However, Jay Powell, Fed chair, gave such dovish signals in his press conference amid a pattern of reasonable US growth that markets expect another rate cut later this year.
The European Central Bank also remains set on an ultra loose course. So do most emerging market countries. Indeed, it is hard to find a central bank today with a tightening mission, other than the Swedes who raised rates from negative to zero in December.
Is this good news? Many investors might shout “yes”. Most asset prices have soared recently. “Very few people expected 12 months ago that we would see the returns we have seen in the markets in 2019,” Anne Richards, head of Fidelity International, said at the World Economic Forum’s meeting in Davos last week. “A flip of [central bank] petrol on the fire can get things going.”
Measures of financial conditions illustrate the point. Consider the “financial stress” index calculated by the St Louis Fed, from a composite of market rates and credit spreads. Between 2002 and early 2007, this index moved from plus 1.064 to minus 0.618 (a negative number indicates loose conditions).
Then, in the 2008 crisis, it surged above 5, before falling below minus one in 2012, as central banks offered support. Last autumn it sank even further and now stands at minus 1.567, its lowest level since records began in 1994. The Chicago Fed’s financial conditions index, which tracks Main Street conditions, echoes this. This implies that funding is even cheaper today than during the pre-crisis credit bubble.
But before investors feel too jubilant, they should consider two further points. Firstly, in spite of this deluge of central bank petrol, recent growth has been far lower than economists might have expected with this much financial easing. “Why has the loosening of financial conditions not offset more of the growth slowdown?” BlackRock asked in a recent research note that went on to blame geopolitical uncertainty.
Secondly, even as this super-loose policy causes asset prices to soar, it is destabilising the investment strategies of many mainstream investors, including pension funds and insurance companies. “The key question is, ‘how do you make money in an environment of negative rates?’” said Paco Ybarra, head of markets at Citi, adding that falling rates and volatility have tipped the system into “a financial ice age”.
To compensate, mainstream investors are buying assets of longer duration, lower credit quality or in much riskier parts of the world. “We have to pick our risks,” said Ms Richards.
The Fed denies that this poses serious dangers to the financial system. But some financiers are becoming alarmed.
“I don’t see a crunch this year, but this feels like 2005. The music is playing so everyone is dancing, but the risks are piling up,” one hedge fund luminary recently told me. Keishi Hotsuki, Morgan Stanley’s chief risk officer, said this week. “Right now there is so much buying power in the market that it makes me nervous . . . about complacency.”
Indeed, Mr Hotsuki says he would welcome a modest market correction. Puncturing this complacency would “be better long term”. He might get his wish: the spread of the coronavirus in China has already caused a wobble in asset prices.
But here is the trillion-dollar rub: if a shock does occur — from the coronavirus or anything else — investors are likely to expect, even demand, even more central bank support. After all, when US repo markets gyrated last autumn, the Fed rushed to help. Mr Powell may have said he expects to slow down those repo interventions later this year, but few financiers believe this would occur if jitters re-emerged.
We are starting a new decade with a financial system and investor base that is hooked on central bank support to a greater degree than we have ever seen before. Few predicted this a decade ago. But even fewer expect it to end this year, in Japan or anywhere else — even though the addiction is deeply unhealthy, not just for investors, but central banks too.
gillian.tett@ft.com
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Source: Economy - ft.com
