Central bank communications may be less obvious than they seem
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Over the months ahead, the statements made – and not made – by central banks can be expected to have material influence on market sentiment and asset pricing, and with this in mind, it’s interesting to look back on the conduct of the Bank of Japan during the early and mid 2000s, when Japan grappled with the sort of debt-deflation and growth deficit problems that face many developed economies today.
Back then, and perhaps with the benefit of hindsight, we could argue that the Bank of Japan’s Quantitative Easing (QE) policy was not really intended directly, or managed, to create or to ‘print’ money to any significant extent. Instead, the QE policy was designed primarily to provide guidance on the likely (long) duration of the zero interest rate policy that had been put in place. By committing themselves to a programme of QE, the central bank was in effect announcing that they could not raise interest rates for practical reasons until the QE ended.
Hence, in 2005 when the Bank of Japan started to signal that the QE policy would likely be discontinued from March 2006 onward, the markets and in particular the banks’ investment departments were given a date from which short term interest rates could theoretically rise. This then led to a change of behaviour by the commercial banks, particularly with regard to their own activities within the bond markets, and the key point is that for all the chattering over so-called printing money, quantitative easing episodes in Japan, before ‘Abe-nomics’ were only really ‘signalling tools’ used by the central bank to help set interest rate expectations within the private sector.
In the US today, their QE3 may have been working much more as a ‘printing press’ form of QE than its predecessors in title, but nevertheless it also has had a signalling role. However, by indicating that the outlook for QE3 and by extension the prospect of tapering is data dependent, Mr Bernanke has, unwittingly or otherwise, compromised this signalling role and the certainty that it had provided with regard to the future trend in interest rates. That the signalling role of QE has been compromised can be discerned by looking at the behaviour of the US commercial banks, which were once major buyers of Treasury bonds along with the Federal Reserve Board, and are now ongoing sellers, thereby undermining the effect of the current QE on both the liquidity and the trend of bond market pricing already.
This raises an interesting set of questions.
First, we ought to decide if we think that Mr Bernanke would have been aware of what his comments would do. Of course it’s possible that he wouldn’t and wasn’t, but this seems scarcely credible given his experience, let alone the legion of highly qualified and very experienced staff at the Federal Reserve.
So the second question is, just assuming that he was aware of what would likely happen, whether Mr Bernanke really intended to draw QE to a close, without actually having to do so formally. This would seem consistent with the premise that he would have known what his words and actions would deliver, and it would then follow that the Fed had become increasingly concerned with regard to the unintended consequences for markets from QE3.
As for the real world consequences, whilst Mr Bernanke remains publicly committed to QE3, and can continue with it, and indeed any withdrawal from QE3 may be premature notwithstanding the distortions it has created, we can conclude that in a very practical sense, exit from QE3 is already underway.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
