Up and Down Wall Street

Central Banks Seek More Ammo for the Bazooka

The ECB goes deeper into negative rates while the Federal Reserve is likely to hold off for now. One radical option: Drop money from the helicopter.

By Randall W. Forsyth       

Pity the poor central bankers of the world. They’re having a harder time than ever pushing out torrents of money into the world’s economies.

First they reduced interest rates to zero. Then they bought boatloads of bonds with money they conjured up electronically and shoveled out the door. But still, they had to get even more creative by cutting interest rates below the previously presumed lower boundary of zero.
Negative interest rates turned the world upside down, with depositors and bond investors paying for the privilege of investing their money and borrowers, in some cases, being paid for borrowing.

There have been more radical schemes put forth, notably “helicopter drops” of cash, to use the metaphor originated by economist Milton Friedman and repeated by former Federal Reserve Chairman Ben Bernanke. Government borrowing to cover a deficit resulting from a tax cut or spending scheme that was funded by central-bank money printing would be the equivalent to Friedman’s metaphorical cash drop, Bernanke explained back in 2002, earning him the nickname Helicopter Ben.

One might presume that getting central bankers to run their printing presses would be as easy for them as falling off a log. But Jeff deGraaf, who heads Renaissance Macro Research, last week noted that the year-over-year expansion of global central-bank liquidity (from the Fed, the European Central Bank, the Bank of Japan, the assets of the People’s Bank of China, and China’s currency reserves, plus assets of sovereign-wealth funds) has turned negative. That’s a far cry from the double-digit annual growth rate seen as recently as late 2013, when the Fed began its “taper” of bond buying. Lo and behold, the year-over-year change in the Standard & Poor’s 500 index turned negative.

But fear not. A new way to get money from the central banks into the hands of the people was invented by an unlikely source.

Actually, they did it the old-fashioned way: They stole it. It seems that computer hackers purporting to be the central bank of Bangladesh were able to transfer some $101 million from the New York Fed, according to various press reports. A $20 million batch went to a bank in Sri Lanka, which didn’t disburse it, according to a Sri Lankan central-bank spokesperson quoted by the Financial Times. The other $81 million was transmitted to accounts at a Philippine bank, where authorities were working with Bangladesh and had frozen the accounts.
Not surprisingly, the Bangladeshis want their money back, but the New York Fed insisted it hadn’t been hacked and followed protocol in making the transfers.

If the dough isn’t recovered, the central banks might console themselves that the money probably will be spent and provide real monetary stimulus—possibly getting more bang for the 100 million bucks than their more usual policy operations aimed at boosting asset prices and in turn spurring spending and investing.

When you think about it, negative interest rates are a bit like a bank robbery in reverse. You give a borrower money for some period of time, and you get less back for your trouble. The idea is that you’d rather get something for your money, so you’ll look for some investment with a positive return. Anyway, that’s how it’s supposed to work, but so far the results have been mixed.

The problem is that banks in countries with negative rates, such as the euro zone, Switzerland, Japan, Denmark, and Sweden, can’t bring themselves to charge depositors to hold their money. In other words, they’re not like airlines, at least not yet. So, the banks eat the negative rates on some of their balances at the central bank. Meanwhile, the gravitational pull from negative rates results in lower bond yields and loan-interest fees, squeezing the banks’ profits.

Last week, the ECB came up with a new twist on NIRP, which is the acronym popular in central-banking circles for negative interest-rate policy. So while Mario Draghi’s crew last week said it will lower the rate the ECB charged banks by 10 basis points (0.1 percentage point), to minus 40 basis points, they came up with a new twist. The ECB would provide banks with long-term cash, free of charge but with a twist: The central bank would pay the banks 40 basis points if they actually made loans with the money.

In addition, the ECB also upped its monthly bond purchases to 80 billion euros ($89 billion) from €60 billion currently. And the central bank will start buying corporate bonds from European nonfinancial corporations with investment-grade credit ratings.

All of these novel moves left markets flummoxed on Thursday when Super Mario announced his latest moves. The “bazooka”—to use former U.S. Treasury Secretary Hank Paulson’s term for powerful policy tools—first rallied the markets but then backfired, to use the metaphor uttered throughout the market.

The euro plunged and bourses rallied on the prospect of more cheap money driving profits of euro-zone corporations. But those moves snapped back, and more, after Draghi almost offhandedly indicated that rates were unlikely to be pushed still lower, and the euro popped and stocks tanked.

After further review, on Friday, markets reconsidered the novel ECB moves to spur more credit in the private sector via the lending facility and corporate-bond purchases. On the latter score, there may be unintended beneficiaries. Before the ECB schemes were announced, Berkshire Hathaway (tickers: BRKA, BRKB ) sold €2.75 billion of euro-denominated bonds on favorable terms to help fund its acquisition of Precision Castparts. Even though the ECB won’t be buying issues from non-European issuers such as Berkshire, there will be lots of euros looking for bonds to buy.

Attention this week shifts to the ECB’s counterparts. The Bank of Japan meets on Tuesday, from which little is expected, especially given how its adoption of NIRP in late January largely backfired by sending the yen sharply higher, not lower, as the textbooks would indicate. On Thursday, the Bank of England also should keep policy on hold.

SANDWICHED BETWEEN THE BOJ and BoE will be the main event of the week, the two-day meeting of the Federal Open Market Committee that winds up on Wednesday. Forgive the repetition, but this will be another confab to watch what they say instead of what they do.

There’s roughly the same chance of the Fed’s policy-setting panel this week enacting its second rate hike of this cycle as Donald Trump getting a buzz cut. The real revelation will come in the FOMC’s rhetoric about prospects for future moves, the so-called dot-plot graph of the members’ projections of the federal-funds rate target at the end of this year and next (with guesses beyond to show that the FOMC has a sense of humor), plus revised economic projections.

Since the start of the year, when various Fed officials, notably Vice Chairman Stanley Fischer, opined that four rate hikes in 2016 were in the ballpark, the consensus view has softened to perhaps two increases this year from the current funds rate target of 0.25% to 0.5%. In the fed-funds futures market, the movement has been in the opposite direction in the past month or so; from pricing in about a 50% chance of a single rate hike, and not until December, to slightly better-than-even money on a June hike and better than three-in-four odds by year end.

So, while the dots will likely come down in Wednesday’s plot, JPMorgan Fed watcher Michael Feroli observes that they’ll still be higher than market expectations. As for the FOMC statement, he thinks a balanced assessment of risks is most likely, as opposed to January’s statement when Janet Yellen & Co. “essentially punted” by saying they were watching developments, notably the deterioration in global financial markets.

The recently increased odds in the futures market for a Fed hike have coincided with the recovery in risk markets, mostly high-yield bonds and stocks related to commodities, which have rallied in tandem with crude oil and metals. Not for nothing, commodity stocks were among the most heavily shorted names, so reversing those sales has made for outsize pops.

So far, the actions of central banks have, shall we say, trumped all of the political uncertainty.
Tuesday brings make-or-break primaries for the #NoTrump contingent in the GOP. The positioning to block the Donald reached such an extreme that Florida Sen. Marco Rubio was urging his Ohio supporters to vote for John Kasich, the state’s governor, to keep Trump from locking up the nomination ahead of the convention in July. Meanwhile, Vermont Sen. Bernie Sanders upset former Secretary of State Hillary Clinton in last week’s Michigan primary, pointing up her shortcomings as a candidate.

The relevance to the stock market is that continuity counts. According to Bank of America’s Global Wealth & Investment Management group, since 1928 the S&P 500 fell an average of 2.8% when an incumbent president was not seeking re-election. When a sitting president was seeking another term, the S&P 500 averaged a 12.6% return.

These days, not only isn’t the incumbent not running for re-election, but rarely has there been such a free-for-all for the White House. At least the remaining GOP contenders called a halt to their childish behavior and negativity in Thursday’s debate. That said, markets should expect the worst from the political sphere and hope for the best from the central banks. 

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