Strange things are afoot in the world of central banking. More than six years after the onset of the Global Financial Crisis, central banks are being forced to fight a sudden battle against disinflation amid the ongoing silent war against deflation.
Over the past couple of weeks, a number of central banks have shifted to a dovish stance on the future direction of interest rates, if not outright monetary easing.
Although the slowing global economy is the primary factor behind their about-face in policymaking, the collapse in crude oil prices along with anticipation of other central banks' future moves, particularly the European Central Bank and the U.S. Federal Reserve, is what's driven their timing.
Nevertheless, many of these moves have caught a lot of people, including traders, economists and other financial experts, by surprise.
The first shot across the bow, by the Swiss National Bank (SNB), was actually more akin to monetary tightening than easing.
On Jan. 15, Switzerland's central bank decided to abandon its currency ceiling against the euro. Following that announcement, the Swiss franc jumped as high as 30% against the euro, though the latter quickly recovered and is now down about 13.4% from the level that prevailed prior to the policy change.
The Swiss central bank undertook this action out of the expectation that the European Central Bank (ECB) would soon launch a bond-buying program similar in scope to the so-called quantitative easing program that the Fed recently concluded.
Since 2011, the SNB had kept the franc pegged at a level of EUR1.20 to counteract the currency's safe-haven status, which had enticed significant capital inflows, particularly during the Continent's sovereign-debt crisis, that could have boosted the country's currency to levels that would have hurt its exporters.
But with the ECB all but set to provide further easing, the SNB believed the cost of the peg would prove unsustainable, with one estimate that defending the cap would have cost nearly USD110 billion in January alone.
The Swiss central bank faced a number of bad options and ultimately decided that removing the peg was its least-bad choice, though the country's exporters described its action as having unleashed a virtual tsunami.
More recently, SNB's vice-chairman said the bank could intervene in the foreign-currency markets to dampen the effect the lifting of the cap has had on the franc. In other words, the bank could counter its implicit tightening with a bit of easing.
Of course, the ECB fulfilled Swiss central bankers' expectations, and then some. With its benchmark rate already close to zero, on Jan. 22, the ECB announced a stimulus program that would be roughly double what economists had expected: The central bank says that starting in March it will buy EUR60 billion of bonds per month through at least September 2016, a program totaling at least EUR1.1 trillion.
Meanwhile, Denmark's central bank has cut rates three times in the past 10 days in defense of its own strict peg against the euro. Further rate cuts are expected, with analysts from Nordea observing, "The peg will be defended vehemently."
Even Russia's central bank, which had made the incredibly dramatic move in December of boosting its key rate to 17% in an effort to stave off a currency panic resulting from the country's exposure to collapsing energy prices, today announced that it would be backing off a bit by lowering the rate to 15%.
Another Day, Another Surprise Move
Similarly, over in Asia, central banks are trying to get ahead of the Fed with easing of their own.
On Jan. 15, the Reserve Bank of India announced its first cut in 20 months, reducing its policy rate by 25 basis points, to 7.75%. Further cuts are expected.
Then on Tuesday, Singapore's central bank said it would reduce the band within which the city-state's currency is allowed to appreciate against a basket of currencies. That's the main way in which Singapore conducts its monetary policy, and this latest action is tantamount to an easing measure.
And even the Reserve Bank of New Zealand, which had been one of the few central banks in the developed world with a hawkish stance toward monetary policy, including four rate hikes last year, announced on Wednesday that it would be shifting into neutral by maintaining its benchmark cash rate at 3.5% for some time.
Down under, the Reserve Bank of Australia (RBA) also appears poised to cut rates, possibly as soon as its meeting next week. Based on futures data aggregated by Bloomberg, a majority of traders are now betting on a quarter-point rate cut at the upcoming meeting.
The RBA had already embarked on a rate-cutting cycle starting in late 2011, eventually lowering its short-term cash rate to an all-time low of 2.5% in August 2013, and it's been in a holding position thereafter.
And, of course, as we wrote last week, a day prior to the ECB's announcement, the Bank of Canada (BoC) delivered a shock of its own, cutting its benchmark overnight right by 25 basis points, to 0.75%. And while the BoC described this action as an insurance policy, implying a one-off move instead of a new easing cycle, a slight majority of traders are now betting on yet another cut at the central bank's March meeting.
A Cavalcade of Jaw Droppers
If your head is already spinning from this rundown, imagine what it's like to be a currency trader amid this tumult.
In an interview with The Globe and Mail, one trader who specializes in foreign-exchange markets, said what began as a calm day quickly turned to pandemonium following the BoC's surprise rate cut.
"My jaw hit the desk," he said. The rest of his day was spent scrambling to reposition client assets. Naturally, given that virtually no one expected the central bank's move, some clients were in positions that had taken a beating, and he conceded, "I received a few phone calls that had maybe some explicit language. People were very shocked."
Now imagine this scenario getting an almost daily replay over the past two weeks at currency-trading desks across the world. Sure, these guys probably get paid pretty well, but by now some of them must have the white-collar equivalent of the thousand-yard stare.
Kicking the Can Down the Road
So where does that leave us? For one, it's deeply troubling that amid all the happy talk about the U.S. economy's gathering momentum, the rest of the world's economies are weakening.
According to the World Bank, the U.S. only derives about 13% of its gross domestic product (GDP) from exports, while exports account for a more substantial 30% of Canada's GDP.
But while these data might suggest the U.S. can afford to go it alone, the Global Financial Crisis proved that the world is far more interconnected than ever before, particularly among financial institutions.
It remains to be seen whether the Fed is willing to start raising short-term rates amid such an environment. The federal funds rate has been zero-bound now for more than six years.
Although the Fed's mandate concerns domestic matters of achieving full employment while maintaining price stability, it does take the exchange rate as well as international developments into account with its policymaking. The bank has acknowledged that even once its two main objectives are met, it could conceivably hold rates at historically low levels "for some time" should economic conditions warrant.
The Wall Street Journal's Jon Hilsenrath, who's been jokingly referred to as the Fed Whisperer, says the central bank's self-described patient stance toward monetary policy is likely to continue until mid-year, though its latest language suggests it could wait even longer to start raising rates.
As we've seen since 2009, monetary easing goes a long way toward bolstering economies and inflating certain asset classes. But as many central bankers have admitted, there's only so much their monetary largesse can do.
But we'd rather have aggressive easing and the eventual inflationary reckoning that could come as a consequence than suffer an out-of-control deflationary spiral.
This article originally appeared in the Maple Leaf Memo column. Never miss an issue. Sign up to receive Maple Leaf Memo by email.
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