Economist Insights Quantitative teasing - UBS

4 downloads 658 Views 226KB Size Report
Economist Insights. Quantitative teasing. 22 July 2013. Asset management. They pledged eternal love (well, QE-ternity), but then threatened to take it all away ...
Asset management

22 July 2013

Economist Insights Quantitative teasing Joshua McCallum Senior Fixed Income Economist UBS Global Asset Management [email protected]

Markets may feel they are being teased by the will-theywon’t-they of central bank QE decisions. In this week’s piece, we provide seven pieces of relationship advice for markets and central banks during these turbulent times. The markets need to learn to see monetary policy from the central bank’s perspective, not just their own perspective.

Gianluca Moretti Fixed Income Economist UBS Global Asset Management [email protected]

They pledged eternal love (well, QE-ternity), but then threatened to take it all away (tapering) while promising they would still be friends (rates on hold). When markets are being teased like this, it is no wonder they are confused about their relationship with central banks. For this relationship, economists are the ‘agony aunts’ so here are seven pieces of relationship advice for the markets during these turbulent times. 1. “Think about what your partner wants, not what you want from your partner.” The market craves certainty; it is a very needy partner that way. Central banks want to do the right thing for the economy, so they need the flexibility to react to the data as it changes. The two demands are mutually exclusive, so the market will always be disappointed with the amount of certainty that central banks can provide. 2. “Don’t over-interpret every little thing they do.” This follows on from the first piece of advice. The market dissects every statement and pores over every speech to look for clues that will provide the certainty about monetary policy that they so desire. Unfortunately, that certainty does not exist. To add to the problem, central banks are partners with multiple personalities: the messages vary with the speaker. 3. “Commitment is a big step – don’t ask for too much too quickly.” At times, a central bank will be willing to make some commitment to provide at least a bit of conviction if not

absolute certainty. Forward guidance on interest rates is a form of commitment, but a central bank will always leave wiggle room to change its mind if developments change. In the last few weeks, Chairman Bernanke has made it abundantly clear that the 6.5% unemployment rate in the US Federal Reserve’s forward guidance is a threshold, not a target. Even though he is unlikely to be Fed Chairman at the time, he clearly expects the Fed to let the unemployment rate go right through that threshold and even lower. The Bank of England has not yet adopted forward guidance, but its thresholds will likely be flexible as well. Talking down the relationship Implied increase in interest rates by Q4 2014 0.75

0.50

0.25

0.00

-0.25 Jan

Feb

Federal Reserve

Mar

Apr

May

Bank of England

Source: Bloomberg, UBS Global Asset Management

Jun

Jul

4. “Remember that there is more than one way to express affection.” As soon as the Fed announced the possibility of tapering, the market thought that the days of easy policy were over. To the market, tapering means a more optimistic Fed which means earlier rate hikes. In fact, the opposite is more likely to be true. QE is a very uncertain tool. Dovish central bankers are worried that extra QE may have little impact, while hawkish central bankers are worried about potential side effects (see below). This creates a consensus for less QE as long as a decent substitute can be found. Most doves would be happy for more extended forward guidance (lower for longer) because they are more confident about the benefits of forward guidance. Most hawks are less worried about the side effects of forward guidance than of QE. This means that early tapering could actually mean later interest rate hikes. Note how keen the Fed has been to stress the difference between tapering and rate hikes, and also how the doves in the Bank of England did not vote for QE but only because they preferred a different ‘mix’ of support for the economy. Recently, the market has started to understand the distinction and is pricing in later rate hikes (see chart). 5. “Sometimes you have to be cruel to be kind.” This is actually advice for the central banks, but it will be better for the markets if they understand that central banks sometimes have to be the bad guy. A number of central bankers have been worrying about the possibility of bubbles generated by excessive liquidity. Some are worried that this liquidity could lead to investors underestimating risks in general. For these central bankers, a painful but necessary reminder that liquidity can go the other way was required, and the talk of tapering by the Fed provided just such a reminder (as anyone who was holding a lot of government bonds in early May could tell you).

6. “Don’t push them too hard – they may push back.” Markets act as if their reaction can be completely independent of what central banks do: the central bank acts, the market reacts, and that’s that. The relationship is actually more reciprocal than that. Central banks do not target the short rate and the quantity of money purely for the sake of it. They use these as instruments to change borrowing costs and returns on savings: in short, central banks are really targeting the yield curve. If the market reacts to prospective tapering or tightening by pushing yields up too much, this will constitute a tightening of financial conditions. That will then slow growth, which means that the central bank will actually have to further loosen monetary policy. This can be a very volatile process but the market should not forget that ultimately the central bank will react to sharp increases in yields. 7. “Don’t take them for granted.” The central banks that people thought they knew well six years ago are no more. So many pre-crisis taboos of central banking have been broken that the really clear message is that you should never underestimate what the central banks might try. Just because some of them are shifting out of easing mode does not mean that they have lost the capacity to surprise the market. At least that helps keep the relationship fresh.

The views expressed are as of July 2013 and are a general guide to the views of UBS Global Asset Management. This document does not replace portfolio and fundspecific materials. Commentary is at a macro or strategy level and is not with reference to any registered or other mutual fund. This document is intended for limited distribution to the clients and associates of UBS Global Asset Management. Use or distribution by any other person is prohibited. Copying any part of this publication without the written permission of UBS Global Asset Management is prohibited. Care has been taken to ensure the accuracy of its content but no responsibility is accepted for any errors or omissions herein. Please note that past performance is not a guide to the future. Potential for profit is accompanied by the possibility of loss. The value of investments and the income from them may go down as well as up and investors may not get back the original amount invested. This document is a marketing communication. Any market or investment views expressed are not intended to be investment research. The document has not been prepared in line with the requirements of any jurisdiction designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The information contained in this document does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular security or fund. The information and opinions contained in this document have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. All such information and opinions are subject to change without notice. A number of the comments in this document are based on current expectations and are considered “forward-looking statements”. Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Global Asset Management’s best judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed. Furthermore, these views are not intended to predict or guarantee the future performance of any individual security, asset class, markets generally, nor are they intended to predict the future performance of any UBS Global Asset Management account, portfolio or fund. © UBS 2013. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. 23213