The Blog

Has Quantitative Easing Become an Embarrassment?

With pressure from a skeptical Senate to wind down QE, and next January's FOMC voter rotation bringing in many new hawks, it seems likely the data would have to become truly appalling before we saw an increase in QE.

Fascinating times. The shifting sands of monetary policy fashion seem to have turned some major central banks against the very concept of Quantitative Easing, as fears that the efficacy (questionable anyway) of QE may not outweigh the risks, namely asset bubbles and a systemically dangerous mispricing of risk.

Nothing lasts forever and the 'dismal science' of economics is constantly reinventing itself. Suddenly arch-dove Bernanke has been forced to raise the prospect that QE may not be infinite, and this week we learnt that the Bank of England's Monetary Policy Committee (MPC) was also united in its decision to refuse to indulge in more QE when it met last on 3-4 July.

The ECB (a.k.a. the Bundesbank) would never countenance QE in the form that it has been deployed in the US and the UK, leaving the Bank of Japan suddenly looking rather isolated.

This makes me even more convinced that the yen will continue a long term descent, certainly vs. USD, GBP, and EUR. There will surely be bumps in the road as risk-off events will still lead to the use of the Yen as a safe-haven - as evidenced by June's terrifying roller-coaster price action, so strap yourself in, and maybe use options to limit downside.

Data dependency is the new buzz-word as the Fed, BOE and ECB have all told us that's the way of things now, with unemployment and inflation the numbers to watch for each month (except the ECB would only admit to unemployment, or anything else except inflation, after several beers). Funny how fashions change in this regard too. As a young interest rate trader at Citibank in the eighties, I used to be glued to the release every Thursday of the US Money Supply figures. Those were the heydays of monetarism, with the Fed intent on killing inflation, whose only root cause was then thought to be the money supply. Milton Friedman was Reagan's economist du jour, and he said 'inflation is always and everywhere a monetary phenomenon'. The Fed bought into this, and so we at our trading desks had to too, as that was the Fed's reaction function at the time.

Now the money supply release doesn't even appear on the Bloomberg calendar of economic releases.

I do feel that today's data dependency is somewhat asymmetric even though the Fed has tried to convince us otherwise. With pressure from a skeptical Senate to wind down QE, and next January's FOMC voter rotation bringing in many new hawks, it seems likely the data would have to become truly appalling before we saw an increase in QE.

In practice this leads to an interesting observation which may indicate a profitable trade. It is now the case that US interest rate futures tend to sell off a little just before big data releases, as a reflection of this asymmetry. Take a look yourself, choose an optimal time to sell futures before figures and then buy them back just before the release.

It seems like QE's replacement is to be ubiquitous 'forward guidance', whether the 'threshold dependent' variety favoured by the Fed, or the 'time dependent' alternative tentatively embraced by the ECB, and I'd suggest shortly to be announced by the BOE; it's all about trying to convince us that rates will stay low enough for long enough to ensure recovery. Personally, for the US and the UK, I find these policies at best a flawed concept, at worst quite probably counter-productive, and almost certainly bad for central bank credibility in the long run.

So what's wrong with giving individuals and businesses the reassuring message that rates will stay low as far as the eye can see? It's all about the place we are in the cycle. Four years ago, say, this would have been a great message, as it was when Mark Carney blazed the trail by introducing the policy in Canada in 2009, because we had just narrowly avoided financial Armageddon and thought it was quite possible that the economy had entered a permanent winter. Right now, however, things are very different - in the US and UK, at least. The green shoots of recovery are well above ground and taking root, so I believe it's just the wrong moment for central banks to damage psychologies by telling us they're not impressed by our efforts and think they'll have to keep rates low for ages yet. I'd further posit that the fear of rates going higher, is in general, for these economies as a whole, not the major preoccupation. Nobody is afraid that rates will return to the 15% we saw in the early nineties in the UK; borrowing costs of 6 or 7% do not seem life-threatening compared to the present 4 or 5%.

No yield curve forever also drives the bankers' dream of a return to 3-6-3 banking even further over the horizon (borrow at 3%, lend at 6%, and on the golf course with the client by 3pm). So why not borrow at 0.5% and use the money to buy Gilts at 2.25%, with zero credit risk? Wonderful for bank balance sheets, but not much help for the economy.

Meanwhile, investors with spare cash don't find 0.1% deposit rates too exciting and are happy to plunge into emerging market corporate bonds at 4% which, ironically, is just the sort of mispricing of risk that is spooking central bankers.