There is a Cross Atlantic central banking trend taking place, Nomuraâ€™s Richard Koo notes in a July 11 report. The US Federal Reserve, moving to normalize interest rates, is slowly being followed by their European counterparts. This could create a unique market environment, one that a computer algorithm looking for pattern recognition might not pick up the central banking trend, particularly as the Bank of Japan continues to hold interest rates negative.
Developed world central banking trend
The Bank of Canada today announced it is raising interest rates for the first time in seven years, becoming the second G7 nation after the US to do so.
This could be the opening salvo in a developed world central banking trend.
Koo, for his part, looks at central banks in Europe and the UK and notes a shift in tone is being seen, saying the pair “have indicated their intention to follow the Fed’s lead and begin normalizing monetary policy.
When the intention to pull interest rates out of the gutter was announced, rates rose, but still remain at historic levels. The German Ten-Year yield stood this morning at 0.515%, a negative real rate of return when factoring in inflation.
Developed world central banking trend: US Fed is transparent about its interest rate roadmap
A key difference between the US Fed under Chair Yellen and the ECB under Mario Draghi is one partner is communicating thoughts and using their words while the other is less than transparent about their intentions.
Among the central banks that engaged in quantitative easing, only the Federal Reserve has clearly discussed winding down the policy and released details of how and when it will be done, Koo wrote.
Koo, in a similar vein with Goldman Sachs analysis, thinks the Fed will start tapering its balance sheet in September, beginning with baby steps in the fall, with a rate hike likely to paint the December holiday season with a glow.
Koo thinks Chair Yellen who could be replaced in early 2018 when her term expires is attempting to lay down a roadmap for removing quantitative stimulus for the next Fed chair.
While Yellen may have wanted to seek appointment to another term, the fact she can essentially successfully leave office after having conducted what is arguably among the most delicate surgical procedures in Fed history might lead her to thank her lucky stars. It could be up to the next Fed Chair, potentially former Goldman Sachs Chief Operating Officer Gary Cohen, to do what numerous analysts call the heavy lifting of ridding the markets of overly dependent stimulus and putting additional arrows in the Fed’s quiver to defend against the next market crisis.
US loan rates fall as US central bank rates rise
From on odd perspective, while reducing stimulus has been a prickly pear in the fruit basket, it might actually be a benefit to US central bankers in this instance.
As the Fed raises interest rates, loan demand has been going down. Recent data from the US Mortgage Bankers shows mortgage demand is lower as is business loan demand. This has motivated lenders to lower interest rates to attract borrowers at a time when the Fed is hiking.
Koo sees this as a sign the historic quantitative stimulus that has suppressed interest rates well below market levels for an extended period might not be delivering on its promise. “This suggests the US economy is not responding to policy normalization. Ms. Yellen and the others responsible for implementing quantitative easing have argued that this policy had a major impact on the US economy, but if so, lending should have increased. It has not.”
Insight / Analysis / Opinion:
Fed Chair Janet Yellen’s mastery at withdrawing quantitative dopamine without a major market crash should be categorized as brilliant, but likely won’t be. There will come a point when volatility returns to markets. This point is difficult to predict. Goldman says it might be a year from now, a period in time when one of their historical brand ambassadors could be Fed Chair. Watching how Cohen withdraws stimulative dopamine from markets and how he handles a market crash could define his career more so than anything at Goldman.