Now that the US Fed has uncorked the bottle with their first rate hike in several years, central banks around the world are starting to react in interesting ways. As described by Vanguard’s economic team in “Highlights from Vanguard’s 2016 global economic and investment outlook” (December, 2015) , for the first time in many years, the Fed and global central banks appear to be moving in different directions in terms of monetary and rate policy. The general lockstep of economic stimulus is breaking down.
While the ECB, Japan and China still remain focused on finding growth, the Fed and central banks in other, seemingly more stable economies, are adopting policies designed to prop up their currencies to prevent currency-driven monetary deflation, and using financing markets as their tools. Here are a few data points:
- Thursday, January 7th, the central bank of Denmark edged its overnight repo rate up by 0.1 percent in a move to defend the Krone. (The Local DK, January 8, 2015). The Danish bank sees capital outflows towards the EU, where stimulus policies are attracting more investment, as threatening to their independent local currency valuation. A very traditionally minded move, designed to bolster demand for the Krone by offering a more attractive rate.
- The People’s Bank of China (PBOC) has opened up the taps by offering an additional $19.8b (US) in seven day RRP funding, hoping to reduce money market rates, which have spiked dramatically as Chinese equities have entered freefall. (PBOC Injects Most Cash Since September in Open-Market Operations, Bloomberg Business January 4, 2016).
- China’s move contrasts starkly with the US Fed’s intention to expand its own RRP program to boost rates. The Fed program seeks to absorb cash investment from non-Fed institutions, whose market rates are seen to be undercutting Fed governed rates. This move is welcomed by many traditional cash investors, who have long argued that all that stimulus cash laying around (which is not dependent on Fed funding) – together with regulatory divergence that disadvantages Fed regulated institutions – are squeezing them out of the market from both a competitive and a supply standpoint. The Fed’s RRP is paying 25 bps while DTCC GCF(R) was at an average of 44.9 bps last week. The Fed did US$97 billion while GCF did $109.5 billion. The RRP spiked at $475 billion on December 31, 2015.
While no one should argue that the economists and regulators who have been building the new, post-crisis financial system are unaware of the impacts of central bank policy divergence – it is fair to wonder just how the system will react to a return to the pursuit of sectional and national priorities. Is this a stress that the new system can deal with?
It is one thing to mitigate the impacts of private institutions playing high-risk games with the system, which has been the focus of regulatory attention for nearly a decade; it is quite another when governments and central banks start once again to pursue their separate, national and regional priorities within one global system. We have not seen this on a large scale for many years – and certainly not since the immediate aftermath of the crisis. All stresses on the financial system, and all significant shifts in the flow of capital between markets and participants ultimately result in the need for rapid-response liquidity – which is after all the core function of collateralized financing. Will our remade system be up to the challenge, or will we be faced with another wave of emergency measures caused not by risky “shadowy” investor behavior, but by the behaviors of quasi-governmental institutions?
Whatever happens, it is clear that global repo and collateralized financing markets will continue to be the canary in the coal mine – the first to understand and to feel the impacts of the new rate games.