Even central bankers are warning of a looming ‘Minsky moment’
‘The question now is whether other leading central bankers are willing to speak out more forcefully about these risks and, more importantly, unwind their ultra-loose monetary policies’
When the head of the central bank of the world’s second largest economy and one of the most important pressure points in financial markets warns about a possible “Minsky moment”, one would expect international investors to start fretting.
Yet the reaction to the striking statement last Thursday by Zhou Xiaochuan, the outgoing governor of the People’s Bank of China, cautioning against being “too optimistic when things go smoothly [lest] tensions build up, which could lead to a sharp correction, what we call a Minsky moment”, was muted.
While Hong Kong equities fell nearly 2 per cent – the sharpest daily decline since early August – other markets brushed off Zhou’s comments, with US stocks even hitting fresh record highs on Friday as investors become more optimistic about the prospects for tax reform.
However if market participants bothered to reflect on Zhou’s warnings, they would quickly realise that they are the latest in a series of statements by leading central bankers stressing the growing vulnerabilities in markets. While major central banks used to inspire confidence by propping markets up with their ultra-loose monetary policies, policymakers themselves are now warning of the dangers posed by quantitative easing (QE) programmes.
In July, the Federal Reserve revised its assessment of the “vulnerabilities associated with asset valuation pressures” from “notable” to “elevated”, stressing that asset prices continue to climb while spreads, or the risk premium, on corporate bonds keep narrowing amid subdued financial volatility. Fed Chairwoman Janet Yellen, who as far back as July 2014 was cautioning that “equity valuations appear[ed] stretched,” noted at the annual meetings of the International Monetary Fund and the World Bank in Washington earlier this month that stock valuations are “at high levels in historical terms”.
Even the European Central Bank, which is still conducting large-scale asset purchases and has defended its controversial decision to impose negative interest rates to encourage banks to lend more, has expressed concerns about its ultra-loose policies. Last year, Benoit Coeure, a member of the ECB’s executive board, warned of the risk that “the side effects of [QE] are such that the negative consequences prevail”. Mario Draghi, ECB president, has also voiced concerns about QE-fuelled asset bubbles, telling the European Parliament last November that there were “significant vulnerabilities” in eight European housing markets.
Leading central bankers are not only right to warn of the downside risks posed by their ultra-accommodative policies – and, just as importantly, the complacency which QE has bred among global investors – they should have been more outspoken about these threats a lot earlier.
As William McChesney Martin, a former chair of the Fed, famously quipped, “the job of central bankers is to take away the punch bowl just as the party gets going”. The problem is that the party has been going on for far too long, making it that much more difficult for policymakers to bring it to a close in an orderly fashion.
When central bankers start to fret about the consequences of their actions – and even go so far as to warn about a Minsky moment – nearly a decade after the Fed launched QE, they are playing with fire. Investors are worried enough as it is about the effects of a removal of stimulus. In the latest Global Fund Manager Survey published by Bank of America Merrill Lynch last week, asset managers cited the threat of a policy mistake by the Fed or the ECB as the biggest “tail risk” in markets right now.
If Yellen or Draghi were as alarmist as Zhou in their concerns about frothy markets, investors would run for the hills.
While Zhou may have felt emboldened to speak out given that he will be retiring shortly, he put his finger on some of the most acute vulnerabilities in the financial system which the IMF warned about earlier this month but which yield-hungry investors prefer to ignore.
The question now is whether other leading central bankers are willing to speak out more forcefully about these risks and, more importantly, unwind their ultra-loose monetary policies in the face of potentially stiff resistance from markets in the coming months.
The willingness of central bankers to face down QE-addicted markets will depend on a number of factors, not least the outlook for inflation and US president Donald Trump’s choice for the next chair of the Fed, which is expected to be announced in the coming days.
What is clear is that the more concerned central banks become about markets, the more worried markets will become about central banks.
Nicholas Spiro is a partner at Lauressa Advisory