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Pedestrians pass the main entrance to the Bank of England in London. (Bloomberg) |
The united stimulus front of central banks is starting to splinter as 2014 dawns.
The Federal Reserve ― soon to be led by Janet Yellen, who is poised for confirmation by the Senate Monday ― begins pulling back on its quantitative easing amid stronger U.S. growth, and the Bank of England is trying to cool its housing market. The European Central Bank and Bank of Japan lean toward more monetary action to fight weak inflation. The ECB and BOE both hold policy meetings this week.
The erosion of the mostly synchronized stimulus that supported the world economy for the past six years has investors anticipating a stronger U.S. dollar and weaker Treasuries. That’s not to say the era of easy money is over, as the need to guard against deflation ― as well as the fear of unsettling markets or upending economic expansion ― leaves the Fed and its counterparts pledging to keep interest rates at record lows.
“The world’s main central banks have very different things going on, which is an opportunity for investors,” said Scott Thiel, London-based head of the global bond team at BlackRock Inc., the world’s biggest money manager. “It’s very important to look at the economies close to inflection points on monetary policy.”
Thiel predicted last month that investors will see the Fed’s decision to taper its $85 billion in monthly bond purchases as the beginning of the end of central-bank support and will push the U.S. 10-year note toward 3.25 percent by the end of this year from 3 percent at 5 p.m. in New York Jan. 3, outpacing the projected rise in Germany’s 10-year bund yield.
Higher borrowing costs on U.S. sovereign debt and the improving economy will help boost the dollar this year, said Stephen Jen, co-founder of London-based SLJ Macro Partners LLP. The Bloomberg Dollar Spot Index, which tracks the performance of the currency against a basket of 10 peers, rose about 3.5 percent last year.
“Policy paths will be dictated by diverging economic trajectories,” said Jen, who describes himself as “generally bullish” on the dollar. “Partly because of the Fed having launched multiple rounds of QE, the dollar is now very cheap.”
Signs that the world’s largest economy is strengthening may be enough to rally equities in the U.S. and abroad, said Pierre LaPointe, head of global strategy and research at Pavilion Global Markets Ltd. in Montreal. His research shows that shifts in U.S. equities explained about 40 percent of the moves in German and U.K. stocks since 2000.
“As major central banks are set on diverging paths in terms of monetary policy, we find that the U.S. economy will have the greatest gravitational pull in 2014,” LaPointe said.
The Fed is trimming its stimulus as Vice Chairman Yellen prepares to succeed Chairman Ben S. Bernanke when his second term ends Jan. 31; the Senate is scheduled to vote Monday on her nomination. The central bank will pare its monthly bond purchases by $10 billion to $75 billion this month, “reflecting cumulative progress and an improved outlook for the job market,” Bernanke told reporters after the Dec. 18 announcement.
The Federal Open Market Committee probably will continue tapering over its next seven meetings before ending the program in December, according to the median forecast of 41 economists in a Bloomberg survey last month.
The Fed announced its intentions after the jobless rate fell to a five-year low in November and as economists including Martin Feldstein of Harvard University and former Treasury Secretary Lawrence Summers predict the economy will accelerate this year. JPMorgan Chase & Co. economists raised their estimate last week for growth to 2.8 percent, higher than the 2.5 percent they projected a month ago and the 1.9 percent they calculate for 2013.
Manufacturing grew in December at the second-fastest pace in more than two years, and a report scheduled for release this week will show employers added 195,000 jobs last month, according to a Bloomberg News survey of economists.
The challenge for other central banks is that if long-term borrowing costs do rise in the U.S., this may pull up comparable rates elsewhere, threatening more-fragile expansions and forcing a response from policy makers, said Andrew Wilson, chief executive officer for Europe, the Middle East and Africa at Goldman Sachs Asset Management in London.
“Historically, markets are highly correlated, so if we see U.S. rates rising, it’s going to be hard for European rates to stay where they are,” Wilson told Bloomberg Television’s “On the Move” with Francine Lacqua on Dec. 17. “It’s going to be interesting with central banks moving in different directions.”
The ECB is already on the offensive against weak price pressures, cutting its benchmark rate to 0.25 percent in November to shore up inflation now less than half its target of just below 2 percent. Gross domestic product in the euro region fell 0.4 percent in the third quarter, and October unemployment was 12.1 percent, down from a record 12.2 percent.
President Mario Draghi has refused to rule out further cuts and pledged rates will stay low for an “extended period.” He has signaled the bank may be willing to charge financial institutions to hold their cash or offer new long-term loans.
If deflationary risks mount significantly, Draghi will need to start buying assets just as the Fed is winding down, according to Ken Wattret, an economist at BNP Paribas SA in London. Policy makers are split on whether to buy government bonds, meaning they probably would start with private-sector securities, such as assets based on outstanding loans to small-and medium-sized enterprises, he said. (Bloomberg)
