Wednesday, July 17, 2013

Update on Major Central Bank Policies for Investors

Today (July 17th) is a big day for central bank announcements. We have the July minutes coming out of the BoE, Stephen Poloz's issuing his first BoC meeting communique  and of course Bernanke's testimony to congress. 

Bernanke's Testimony to Congress:

In his prepared remarks, Bernanke started by outlining the improvements in the economy in particular with references to the improvements in the housing sector and the recent strong payrolls numbers. The important part of his address was on future course on monetary policy. With regarding to future policy, he emphasized that the course is not "preset" and is dependent on future financial and economic developments. It is also important to link future policy with the goal of achieving the Fed's dual mandate of maximum employment and price stability. In discussion of the two unconventional tools, he tried to distinguish between forward guidance on rates (federal funds rate) and asset purchases (QE) by stating the two has "different roles".The asset purchases were used to improve "near term momentum in the economy" while the forward guidance is use to provide a "highly monetary accommodation for an extended period of time even if the economy strengthen" 

On tapering, the Chairman reminded everyone that the tapering plan introduced in the June press conference is highly dependent on the outlook for economy and financial market stability. The assumption of that plan was continued payrolls growth as seen in recent months (200K per month on average) and inflation (as judged by the PCE which is only at 1%) moves closer to the Fed's 2% inflation target. If these assumptions are proven false, then a change in the original tapering plan must be ratified. The pace of future moderation (tapering) of QE will depend on future course of job growth and inflation outlook, which can change dramatically from what is being forecasted now. 

On forward guidance, the Chairman stated it is important to pay attention to the phrase "at least as long as" in the rate guidance. He added that even though the guidance stated rates will remain low at least as long as the unemployment rate is above 6.5% and inflation is not more than 0.5% above the 2% target, the 6.5% unemployment number is a threshold, not an automatic trigger point. When the economy reaches 6.5% unemployment rate, the FOMC will re-assess the economy to see if it is appropriate for a first rate hike (of the federal funds rate). If the drop in the unemployment rate is due to lower labour participation, then rates will likely remain at the zero bound longer than what the 6.5% threshold suggest. Also, when the 6.5% threshold is reached, an outlook of inflation must also be assessed to see if the committee's 2% medium term inflation goal will be achieved; low outlook for inflation will also mean zero bound interest rate will remain for longer than what the 6.5% threshold suggest. All in all, Bernanke remind investors that even if Fed end QE, the federal fund rates will likely remain at 0% and is unlikely to rise in the future unless economy improves substantially.  

Overall, he stuck pretty much with his old script but repeating and keep repeating the same thing assures traders and investors he will not diverge from those remarks he made on tapering and future course of monetary policy. 


Poloz and the BoC:

Looks like Poloz has made his mark at  the BoC with a slight change in the last part of the April meeting statement: "AS LONG AS there is significant slack in the Canadian economy, the inflation outlook remains muted, and imbalances in the household sector continue to evolve constructively, the considerable monetary policy stimulus currently in place will remain appropriate. OVER TIME, as the normalization of these conditions unfolds, a GRADUAL NORMALIZATION  of policy interest rates can also be expected, consistent with achieving the 2 per cent inflation target", the caps are intended to put additional emphasis on the changes Governor Poloz made. It is clear that he is putting on a more dovish tone with adding "As long as" the weakness persist in the Canadian economy, the considerable monetary policy stimulus (i.e. a low 1% overnight rate) is appropriate. This tone is considerably more stronger than Carney's. In addition, he watered down the statement on returning to a more normalized policy by stating that it will be more "gradual" and it will be done "over time". 

The change in the statement reflected his June speech when he predicted the return to full capacity in the economy will be more gradual since consumer and business confidence takes time to build. 

Carney and the BoE 

Mark Carney in his first policy meeting at the BoE managed to convince his fellow members to stick with a "mixed approach" with forward guidance and tried to strike a balance between doves that wanted an increase in the Bank's quantitative easing program (current at 375 billion pounds) and those who wanted to keep quantitative easing unchanged. Carney had everyone on board with his new policy with vote of 9-0 (most expected 7-2 vote as the 2 doves were predicted to vote for more QE). The Bank's trial run at forward guidance was successful as the added phrase in statement managed to push down gilt yields, push up equity prices and the pound depreciated against most peers. With a full introduction of forward guidance in the next month's meeting, BoE is on course to continue to provide a very accommodation monetary policy to the U.K. economy.


Overall Conclusion: 

All three events today signaled that global monetary policy will still remain accommodative  The most influential one, the U.S. Federal Reserve, provided more clarity on their intention to reduce the pace of their asset purchases (QE3). Although Bernanke did not provide additional new information, the assurance he made in his prepared remarks that monetary stimulus is still needed and repeating that tapering is NOT monetary tightening helped to alleviate fears especially among the traders who interpreted incorrectly his previous statement on tapering. The huge rise in fixed income yields after tapering talk surfaced was pretty much a over-reaction. U.S. 10 year are down below 2.5% from a 2.74% reached after the June job report. Rates may continue to drop further in the short term but in the long term (2.3-2.4% for 10-year treasury) , investors shouldn't forget we are in a rising rate environment

1 comment:

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