Restore monetary sanity — and do the global economy a favour
Carney shouldn’t wait until after Brexit to unwind QE
Ken Fisher
© Bloomberg, AFP/Getty, Dreamstime
Worldwide, flat and inverted yield curves — short-term interest rates approaching or exceeding long rates — are everywhere. Many fear they signal slowing growth or recession. Hence, central banks cut short-term rates, as the European Central Bank and the US Federal Reserve just did.
In Britain, the double Halloween-o-phobia of an inverted yield curve and Brexit heighten pressure on Bank of England governor Mark Carney to follow suit. Instead he should take a better path before his January 31 departure. How? Sell the hundreds of billions in long-term debt the bank bought under its policy of quantitative easing. And he should lobby the new ECB head, Christine Lagarde, to follow his lead.
Conventional central bank wisdom says low rates — the cost of renting money — spur loan demand. So, the thinking goes, cut rates and folks will borrow more, like a store holding a sale. They argue money supply — key to growth and inflation — would rise. This is demand-side thinking. It ignores supply, a stronger influence on today’s lending.
Low rates got us where we are now. Flat and inverted curves usually come from central banks raising short-term rates to fight inflation. But no big central bank hiked in 2019. Instead, yield curves inverted when long-term rates plunged. A year ago, 10-year gilts paid 1.55 per cent. Now? Just 0.46 per cent. Germany’s entire yield curve is negative. Japanese yields are negative at 10 years and barely positive at 30. Ten-year US Treasuries yielded 3.16 per cent a year ago. Now it is half that at 1.53 per cent. Yet global loan growth has dragged. Its Siamese twin, money supply growth, has slowed overall since 2012.
Cutting short-term rates further won’t boost lending much. Why? Banks borrow at short-term rates to fund longer-term loans. Their profit — long rates minus short rates — comes from yield curve spreads. Inverted curves — short rates topping long — kill loan profitability.
Funding costs globally are dirt cheap. Yet with short rates so low, yield curves are flat or inverted. The US’s was positive in January. Today it’s inverted — despite two short-rate cuts. Low long rates squash spreads, shrinking bank incentives to lend. Banks need long rates to rise.
When central banks buy bonds under quantitative easing (QE), long rates fall. The Bank of England tried QE twice. If it were stimulus, lending would have jumped but it dragged. M4 money supply growth was sluggish. Ditto when the US tried it. Loan growth waned during the Fed’s QE, improving only after it slowed bond buying. Inflation? It was sluggish everywhere during QE. In the eurozone, it averaged 1.1 per cent year-on-year since QE started in 2015. The ECB isn’t missing its 2 per cent target despite QE, as many claim. It’s because of QE.
Central bankers fixating on low rates miss something bigger. Businesses won’t launch more projects because of quarter-point — or even full-point — rate cuts. If a project isn’t profitable at current rates it isn’t worth doing at fractionally lower ones — even 0 per cent. The profitability is too scant. Lower rates won’t change that. Forget loan demand.
Focus on supply. Wider spreads between long and short rates encourage bank lending, especially to lower-quality corporate borrowers. That’s what Europe needs. Companies such as Amazon and BP can always borrow. Loan-light banks pinch smaller, lower quality companies that are common throughout Britain and Europe. Stimulating lending, inflation and growth requires lenders eager to fund these borrowers.
Reversing QE is the best way to stimulate lenders. Not at the glacial pace the Fed used until stopping in August. I mean a quick, total disgorgement. The Bank of England should start now — don’t wait until after Brexit. Unwinding QE now would set the stage for a post-Brexit pop, with banks loosening lending just as businesses get the clarity needed to deploy pent-up plans.
Ms Lagarde should follow suit when she takes the ECB’s reins next month. Cancel the ECB’s planned bout of QE and start selling the €2.65tn of long-term debt it bought from 2015-18. US and Japanese central banks should join in, too. Mark Carney would become known as the Pied Piper of monetary sanity, leader of a return to normal central bank balance sheets and higher long rates. Long rates wouldn’t soar — there isn’t enough inflation for that. But they’d rise enough to re-steepen yield curves globally.
The result would be near magic: freer-flowing loans from banks more eager to lend. Business investment would accelerate worldwide, especially in Europe and long-shelved projects would finally be initiated. The global economy would grow faster. Reversing QE would start a revival few expect — the sort of surprise stocks love most.
Ken Fisher is the founder and executive chairman of Fisher Investments and chairman and director of Fisher Investments Europe.
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