Global monetary tightening less predictable

Marc Jones - Financial markets have become hyper-sensitive in recent months as efforts by top central banks to gradually lever up interest rates have become increasingly unpredictable, the Bank for International Settlements said on Tuesday.

The central bank umbrella group said in its first report of the year that the stellar start to 2019 for stock markets had come after central banks like the US Federal Reserve and European Central Bank reacted to the torrid end to 2018.

Fed officials have signalled a pause in its more than three-year run of rate hikes while the ECB is contemplating reintroducing the ultra-cheap funding offerings that were once its flagship crisis-fighting tool.

"The very gradual and predictable monetary tightening process is on pause and has become less predictable," said Claudio Borio, head of the BIS' monetary and economic department.

With inflation in advanced economies showing few signs of flaring up and the global economy losing steam, "the narrow normalisation path is proving to be a winding one", he added.

The BIS links most of the world's big central banks and its reports are seen as an indicator of the thinking that goes on behind the closed doors of its quarterly meetings.

Message

Most of its recent reports have generally encouraged policymakers to get away from record low interest rates, but there was no such a message this time around.

Last year's big drops in European, Asian and eventually US stocks have been replaced by a near 20% leap in the S&P 500 and China's biggest markets, reviving hopes the decade-long global bull-run may not have ended after all.

Global stocks have reflated by more than US$6 trillion, emerging markets have done well even as China's economy has revealed cracks yet yields on uber-safe government bonds like German Bunds have plumbed depths not seen in a very long time.

"Financial markets scrutinise central banks’ every word and deed, taking them as the cue for their ups and downs and seeking perennial comfort," Borio said. "Central banks, in turn, scrutinise financial markets to better understand what the future holds for the economy."

Looking forward

The report also contained a mix of specialist studies.

One looked at how the Fed's "forward guidance" – signals on what could happen with interest rates - has "significantly dampened" the sensitivity of short-maturity US government bonds, but not benchmark 10-year ones, to economic news.

It also found that sensitivity to news could also be suppressed when interest rates were at the Zero Lower Bound (ZLB) - effectively at zero percent - as the ECB's rates and those in Switzerland and Japan still are.

Another looked at the reliance of emerging market economies (EMEs) on foreign bank credit. The share of credit to EMEs from foreign banks has fallen since the financial crisis reflecting an increase in credit from domestic banks.

But it is still around 15-20% of total credit on average and the concentration of that money from the likes of the United States and Britain has risen since the global financial crisis from what was already a high level.

"If an EME gets all of its foreign bank credit from banks headquartered in just one foreign country, developments in that country may have a significant effect on credit provision," the report noted.

Study

Another study found British-based funds had supplied a large proportion of bonds the ECB bought during the 2.5 trillion euro bond buying programme it is trying to wind down, while a separate one cautioned that planned replacements for the tarnished Libor interest rate benchmark may end up squeezing banks and push up lending costs for customers.

The paper said migration to the new rates may come at a price given there is no "one-size-fits-all", a message that won't help regulators with efforts to persuade markets to meet a 2021 deadline to switch away from the old scandal-hit rates. – Nampa/Reuters