Why central banks need to stop this guessing game with markets right now
The central banks of the US, euro zone and Japan are playing a dangerous guessing game with the markets. Right now the US Federal Reserve, the European Central Bank and the Bank of Japan are being less than candid with the markets over their true policy intentions, a recipe for disaster when investors are looking for greater policy reassurance during uncertain times.
Arguably, central bankers are supposed to have a firm guiding hand on the tiller, steering rational expectations for future monetary policy changes in a definite and decisive way. This is critical at a time when markets are losing confidence in the global recovery and getting the wind up about hard landing risks up ahead. Worries about the central banks’ ”will they, won’t they” antics are playing on investor nerves and reducing the market’s appetite for risk.
There have been mixed-messages and double-talk, which have left markets seriously wrong-footed on occasions. The Fed has been contorting the markets over its policy intentions for the last three years. The Bank of Japan remains two-minded over whether interest rate cuts are at an end and the ECB is still muddying the waters about further easing prospects. It is not only misleading, it is also downright confusing for markets.
To be fair, the central banks were dragged into a bizarre world of super-stimulus due to the global financial crash and must be keen to get monetary policy back to normal as soon as possible. But their lack of resolve is condemning the world economy to a zombie-land of sub-optimal growth, embedded deflation risks and never-ending ultra-low rates. Japan has been trapped in this economic underworld for the last two decades, a fate which the US and euro zone are desperate to avoid.
So far, global investors have had a good run for their money, thanks to the cushion of cheap money generated by the central banks over the last seven years. The bull market for global stocks and bonds has come a long way, but there is precious little on policy radar screens right now to offer much hope of extension. At some stage the market’s patience will run out and set the stage for major market mayhem ahead.
Investors are all ears to the Fed right now after their most recent policy minutes made strong hints that the US economy might be ready for its next interest rate increase in June. But Fed officials hardly seem to be singing from the same song sheet and the lack of consensus still continues to whipsaw expectations.
The Fed knows the markets are hanging on its every word, so it is so vital to stay consistent and act on a united front. The Fed must be very clear about which variable holds the whip hand for the next policy move – whether it is meeting full employment, hitting its inflation target, or speeding up potential growth. If the Fed is upfront with the markets, the process of clarity, trust and credibility will start to repair.
The Bank of Japan needs to be much more open about its true policy drivers as well. The BOJ’s equivocation over its targets for growth, inflation and the yen exchange rate is leaving the markets at a loss. Judging by last weekend’s Group of Seven meeting of the major industrial nations, it is creating a rift between the US and Japan over currency policy, particularly after recent dollar-yen moves. If they remain at loggerheads, the markets will only exploit the opportunity and ramp up forex volatility.
In Europe, a united front on policy is an absolute priority for the ECB to preserve euro zone financial stability. Growing German opposition to further ECB rate cuts and open-ended quantitative easing are hardly soothing investor jitters about renewed euro zone contagion risks. If the economy starts to falter, the old tensions will resurface again, the euro will take a dive and the bond and equity markets of the troubled euro zone economies will suffer.
It is time for the central banks to be forthright with the markets. The US needs to stick to its guns on moderate tightening. The BOJ needs to be clear-cut that its easing bias remains intact. And Germany needs to allow the ECB time for its QE monetary medicine to work.
Most importantly of all, the US needs to step aside and allow Japan some latitude for extra yen competitiveness. Working together, the central banks can still succeed.
David Brown is the chief executive of New View Economics