By Nicholas Spiro
For a dramatic policy measure described by one investment strategist as a “big regime change”, the decision by the Bank of Japan on Jan. 29 to cut interest rates to -0.1% has done little to buoy market sentiment. The move added the BOJ to a growing list of central banks that have lowered borrowing costs below zero to boost bank lending and thus bolster growth and inflation.
No sooner did global equity markets rally and the yen weaken nearly 2% against the dollar to 121.06 in the hours following the unexpected burst of monetary stimulus — the benchmark U.S. S&P 500 index even had its best day in percentage terms since September — than sentiment began to deteriorate again as a sudden outbreak of extreme bearishness engulfed markets.
On February 8, European equities fell to their lowest level since October 2014, dragged down by a plunge in global bank stocks as persistent concerns about the weakness of the world economy and low oil prices morphed into more acute fears about the stability of the financial sector — particularly in Europe. This prompted a “flight to safety”, with yields on core government bonds falling sharply. On February 9, the yield on Japan’s 10-year bond dipped into negative territory for the first time, while the yen — still treated as a “safe haven” despite its dramatic slide against the dollar since 2013 — rose to Y115.36, significantly stronger than just before the BoJ’s rate cut and precisely the opposite of what Japan’s central bank was hoping to achieve.
Indeed the BoJ’s latest stimulus measure, while partly responsible for the further decline in Japan’s bond yields, is now perceived as something of a sideshow, with fears about the health of the banking sector taking centre stage. Yet these concerns stem partly from central banks’ own monetary policies which are pushing down interest rates to levels that are flattening bond yield curves, shrinking the profits banks make on loans.
For the first time since the outbreak of the financial crisis in 2008, central banks are in the uncomfortable position of contributing to the deterioration in market conditions.
Central Banks: Losing Their Touch
Does this mean the world’s leading monetary guardians — in particular the BOJ and the European Central Bank, which are pursuing full-blown quantitative easing programs and have more or less committed themselves to provide further stimulus in the coming months — have lost their power to act as circuit-breakers for turbulent markets?
If so, has the so-called “central bank put” — the post-2008 financial crisis safety net provided by ultra-loose monetary policies that has inflated asset prices and encouraged investors to take risks — finally lost its effectiveness?
The investment strategy team at Bank of America Merrill Lynch is among an increasing number of market commentators who attribute the sharp deterioration in market conditions last month to a growing loss of confidence in central banks’ policies. The risk of “policy impotence and ‘quantitative failure'” is rising, BAML claimed in a report on Jan. 21.
Central banks are clearly no longer the sources of stability and reassurance they were in the three or four years following the financial crisis.
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