In an interview on 31 July 2018, Russell Silberston and Lindsay Williams discuss the role of central banks, looking at some key decisions happening around the world this week.
Lindsay Williams: As always on a Tuesday, it’s the Big Picture sponsored by Investec Asset Management. This week we are speaking to Russell Silberston, Head of Multi-Asset Absolute Return at Investec Asset Management in London.
We are going to talk about central banks. Now this is the central bank description by Wikipedia. It says here: “A central bank, reserve bank or monetary authority is an institution that manages a state’s currency, money supply and interest rates.”
Russell, the thing that I like about central banks is their almost monopolistic power and the fact that they set the price of money. So whether you are rich or poor or all points in-between, what the central banks do affects your life every single day.
Russell Silberston: Absolutely and without a doubt. Although there is an argument that they are technocratic, actually the parameters around which they do that are actually set by government but no doubt at all they set the price of money in accordance with government and, yeah, we can’t escape from it and, particularly I think over the last 10 years, their actions have prevailed across markets, no doubt at all.
Lindsay Williams: Yes, indeed. Let’s get to this week now and let’s get contemporary and let’s talk about what happened this morning first of all. Let’s start with a really big central bank, the Bank of Japan. There were some rumours that they might, because of their recent trends in consumption spending in Japan, actually change their policy and start to rein in their incredibly expansive stimulus programme which has been in place since Mr Abe came to power but what happened this morning, I don’t think so.
Russell Silberston: No, absolutely. So the Bank of Japan is sort of the Cinderella of global markets and they never sort of get to go to the ball. Everyone sort of forgets about them. They actually kept interest rates unchanged but what they have done is tweak how they implement and it might be worth just going back to assess what they are actually doing.
They are hyperactive in terms of trying to get inflation to take off in Japan. So they are printing money; they are controlling the bond market by buying all bonds above a certain yield level; they are buying equities; they are buying exchange-traded funds, and they just cannot get inflation to go up in Japan, which is a real surprise, but what we saw last week actually was a little bit of kite-flying. Really, Japan has got to the point where this sort of hyperactive policy, I think the side effects are beginning to outweigh the benefits and this is really what this meeting was all about.
It’s actually very interesting. What they actually did was they were buying all Japanese government bonds in a range above 0.1%, 0.1% at 10 years, so that is pretty significant. What they actually did was allow yields to move a little bit further around this. It is now up to 0.2%. It does not sound like much but the Japanese government bond market is monumental. There is $10 trillion outstanding. They are borrowing $1.3 trillion this year alone, this financial year alone and yet there have been days this year where that bond market has not traded, which is absolutely incredible because they have essentially capped all the activity.
So what they are trying to do is offset some of the side effects of this really, really aggressive policy by sort of tweaking some of their operations and, as with markets, I think people sort of over-anticipated this a little bit and, whilst we did see Japanese government bonds sell off, they have sort of given back some of that sell-off today and the yen had rallied slightly and it has also given back some.
I think the significance of Japan is it is not a local market. What happens, of course, to Japanese investors is that money goes overseas, so typically pension funds and individuals indeed buy overseas bond markets. This was beginning to have the anticipation this was beginning to have a global impact and we saw, for example, the long end of the US treasury market and other huge markets sort of rise from 2.95 to 3.10 as the market began to anticipate less flows coming out of Japan and again that market sort of pulled back from some of those gains. So it does not sound like much and it is definitely technical but the facts, you know, it is acknowledgement that some of the sort of costs of this policy are outweighing the benefits.
Lindsay Williams: I tell you what – it may not sound much to you because you are dealing with these numbers all day at Investec Asset Management but it sounds like a gargantuan amount to me when you are talking about trillions of US dollars and it also seems to me that these little tweaks here and there they have to be very careful with because, if the tweak becomes a little bit out of line or out of whack with what the market is expecting, then the international repercussions could be huge for the BOJ (Bank of Japan) and the JGB (Japanese government bond) market.
Russell Silberston: Absolutely agree and they really do have to be extremely careful about it and that is why I think they are just taking baby’s steps in this direction. The policy I think is – you know the policy path is clear. At a global level, central banks are saying look, it’s 10 years since the Global Financial Crisis. We need to begin to escape from this policy because actually there may be a slowdown on the medium term horizon so we cannot go into the next downturn with policy at maximum volume. So I think all around the world we are just seeing central banks pulling back from this really, really high, really sort of aggressive policy.
Lindsay Williams: Let’s talk about central bank event number 2, which is the central bank number 1 in the world when it comes to a league table and that is the FOMC of the US Federal Reserve (FOMC being the Federal Open Market Committee) due to make their decision on US interest rates, US monetary policy in 24 hours or so time. It seems to me there may be no change but that is just sort of warding off the inevitable because the next meeting will probably be another 25 bps according to conventional wisdom.
Russell Silberston: Yeah, absolutely. So the pattern the Federal Reserve has been following is that every quarter they have a press conference, they have new economic forecasts and they have been raising interest rates at those meetings and there is no reason to expect them to do anything different. The communication we have seen since the last meeting in June have all been about being slow but sure gradual rate increases.
Yes, we had fantastic economic growth numbers out of the US last Friday but there is no expectation whatsoever – according to market pricing this morning, there is a 2% probability of a hike this week but it is more like 80-85% for September. So the market is saying, you know, they will probably modestly change the language that they release at the time of that meeting just to perhaps mark that to market if you like but absolutely in September it looks highly, highly likely.
Very little anticipated this time around and the Federal Reserve are just slowly but surely marching towards a tighter policy and don’t forget that balance sheet which is running down and we get to next month, we are running down at close to 50 billion at a month. So whilst interest rates may be unchanged until September, they are slowly tightening policy through shrinking their balance sheet and that again we think will be having an impact at the margins.
Lindsay Williams: We will come to that later on right at the end of the interview but Mr Trump has tried to intervene very subtly (well, if Mr Trump can be subtle about anything) but one of his more subtle comments was: ‘I’m doing this and the central bank is doing something else and raising interest rates’. He is calling for 8-9% growth, GDP growth, for the United States of America, which I don’t think is attainable. It is too big an economy but, anyway, no change tomorrow night – that is your prediction and the market’s prediction apart from the 2% minority. What about the Old Lady, the UK? It is the Bank of England on Thursday. What is Mr Carney going to do?
Russell Silberston: Yeah, absolutely. The Old Lady of Threadneedle Street, as she is known, absolutely, they will raise interest rates. That is sort of 85-90% priced. The UK is an interesting one. We are going to raise interest rates to 0.75. They were last higher in February 2009. Obviously, we were just going into the Global Financial Crisis then but what is interesting about the UK is it is not because demand is so strong. It absolutely isn’t. It is the other side of the economy – the supply side is actually really weak and I think of this as the speed limit. You know, the speed limit in the UK economy has absolutely collapsed post the financial crisis and post-Brexit vote.
So what that means is if you are travelling in the car and you are on a speed limit of 60 mph and you are doing 55, it is not a problem. If the speed limit falls to 30 and you are doing 55, you are in serious trouble and that is what the bank is saying – the speed limit has fallen so even modest growth is going to tighten capacity, spare capacity, in the economy and raise inflationary pressure.
So they are coming about it from a completely different angle, which is quite interesting. So, yeah, it looks to be highly likely despite all the uncertainty and that is what is different about the UK, is this very limited capacity, this very limited room to grow that is really driving them.
Lindsay Williams: Yeah, that actually sounds like the most interesting meeting of all the three that we have just spoken about. Let’s end this now with something that Jamie Dimon, a well-known American investment banking chief, said on CNBC yesterday. He made quite a basic point but a quite moot point as well and he said that we don’t know what is going on here. Seven, 8, 9 years ago we had never really heard of quantitative easing and it is an experiment. Now we don’t know what the unwinding of quantitative easing is (or some people refer to it as quantitative tightening).
So we are in a very, very difficult space at the moment and people tend to panic when they don’t understand something or some drastic change comes about. Hopefully, the central banks manage quantitative tightening as well as they did quantitative easing. Do you think Jamie Dimon has a point because he sounded worried in this interview that I saw?
Russell Silberston: I think absolutely none of us knows. So global central bank balance sheets have grown enormously and they did this really through creating reserves, as we know, and that money had to go somewhere. It was deliberate policy and ultimately, in my opinion, it was the right policy but there has been a monumental [search field] amongst investors as interest rates got cut to zero and we had these sort of portfolio effects of pension funds, insurers – you know, investors had to try and keep returns up, so we have just had this big search for yield.
Historically, no central banks ever unwound their policy in this way. We have seen large balance sheets before historically but that has been a function of war depressingly and, as the economy has grown back, so the balance sheet shrinks as a proportion of the economy. This time around it is actually reducing the balance sheet by outright selling of assets.
None of us know how it is going to go. Arguably, so far, it is only the Federal Reserve that are doing this and that has been offset by the Bank of Japan and, until recently, the European Central Bank but we are getting to a point now where the European Central Bank ending this year and the Federal Reserve are actually actively contracting their balance sheet whereby we need to watch very, very carefully for effects on financial markets. So far, I think it has been incredibly benign actually. Yes, yields have risen in the US and globally, for that matter, modestly but stock markets, you know there is no obvious effect on stock markets.
Yeah, it is a cumulative thing and it is the old analogy of boiling the frog. We need to watch it very, very carefully as the temperature rises that markets do not become stressed but at the moment, in my opinion, there is very little sign of it and I think that will give central banks the confidence to continue with this sort of slow but steady grinding down of those balance sheets.
Lindsay Williams: Russell, brilliant as always. Thanks so much for your time this evening. That is Russell Silberston, who is the Head of Multi-Asset Absolute Return at Investec Asset Management in London.
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