The global economy now lives in wonderland
Not so long ago there was a period when it seemed that world central banks were on the path to normalization. We have been approaching a significant milestone on a long journey since 2008, when in response to the collapse of the global financial system, central banks around the world adopted a number of unconventional political measures. They lowered interest rates to zero. Under the sign of quantitative easing, they have acquired mountains of bonds.
Janet Yellen, then chairman of the U.S. Federal Reserve, ended her quantitative easing program in October 2014. By this time, the country’s central bank had accumulated assets of $ 4.5 trillion. Since then, the balance has been depleted, and interest rates have risen. The European Central Bank (ECB) did not join the quantitative easing game until March 2015, but stopped its purchases in December 2018. Meanwhile, the Bank of Japan was the exception that proved the rule.
Nine months ago, consensus was reached that when the global economy is gaining momentum, it is time to tighten monetary policy. This would allow financial markets to restore something like their normal balance. And that would give central banks the opportunity to maneuver in the event of a possible recession.
What happened then. Now the question is whether the Bank of Japan can really become the new normal. In the face of a sharp slowdown in world production and the transition of investors to a safe place for government bonds, financial markets signal a warning. The Fed’s decision to cut rates by a quarter percentage point and stop cutting bond purchases two months earlier is a sign of a change in mood.
Fed Chairman Jerome Powell, at a subsequent press conference, did everything possible to reduce expectations of a long series of cuts in interest rates. But it was impossible to deny the significance of the moment. This was the first Fed rate cut since 2008. And the markets wanted more. This was enough to provoke angry tweets from President Donald Trump that the Fed is not keeping pace with China or Europe.
Trump is right in one thing. The Fed is not alone in its actions. The People’s Bank of China made it clear that it will provide as many incentives as possible without jeopardizing the threshold rate of 7 yuan per dollar. The last thing the world economy needs right now is for currency movements to provoke further aggression from Trump.
Although the Fed is carefully lowering rates, the ECB is discussing more radical options. European banks already charge a negative percentage for the storage of their deposits. If the rate penetrates deeper into the negative territory, this will certainly cause protests from banks and depositors. Alternatively, the ECB may have to consider resuming quantitative easing, which will require it to find ways around its own voluntary rules that limit the percentage of sovereign debt a member can acquire. The ECB is haunted by the fear that if it goes further, it may be accused of printing money to finance borrowing by member states. The issue of purchasing ECB bonds is pending before the German Supreme Court.
Alternatively, the ECB may follow the Bank of Japan and buy shares rather than sovereign bonds. The Bank of Japan already owns 4.7 percent of the Japanese stock market. This is the path by which no less authority than BlackRock calls for the ECB to go. Apparently, the world’s largest asset manager sees nothing wrong with arguing for the need for open, formal support for one of the world’s most undervalued stock markets.
What happened to change your eyes so dramatically? How did we end up sliding back into the financial twilight zone? And what are the implications for the future?
A darkening mood has both immediate and deeper causes.
The immediate trigger was a deeper understanding of the damage caused by the Trump trade war. It turns out that the increase in tension caused by the belligerence of the Trump administration is harmful not only for the countries that the White House is trying to intimidate, but also for the globalized business as a whole. This is so bad that, despite the fact that the Fed is targeting the US economy, it cannot ignore the returns from the wider world. This influence goes beyond the direct impact of trade wars on the balances of General Motors or American chip makers. The prospect of a retreat into economic nationalism could really scare the markets.