August 5 2016 Market Minute
Despite the interest rate cut of the Bank of England (BOE) this week, for the second week in a row both the US Equity Market and Bond Market were relatively flat. Dow Jones Industrials just off all time highs hit last month and US Treasury Yields also off all time lows hit last month.
Another one of the ‘Super Central Banks’ (SCB’s) met this week. The Bank of England (BOE), as anticipated, lowered interest rates (.5% to .025%) and noted that they plan on lowering it closer to 0% later this year. They also, unexpectedly, renewed their ‘Quantitative Easing’ (QE) program last done in 2012. BOE Governor Carney explicitly said he is ‘not a fan’ of negative interest rates, unlike those actions taken by European Central Bank (ECB), Swiss National Bank, or Bank of Japan (BOJ).
Understanding QE is complicated, even for PhD Economists. Here are some of the basics of it.
QE is strategy most of the SCB’s have engaged in since 2009. QE is where a Central Bank ‘electronically’ creates money and then uses it to purchase bonds. These purchases of bonds thus drive the price of the bonds higher and the yield lower. A lower interest rate decreases borrowing cost in the economy and is ‘normally’ associated with stimulating economic growth.
The BOE, like most of the other SCB’s, is ‘independent’. Meaning, they are able to engage in activities like this without their governments ‘influence’. The creation of ‘money’ in this manner is very different than the normal creation of money via a countries ‘Treasury’, which is not independent and must be given the authority to ‘print’ money by their government.
You may think it is just ‘semantics’, Central Bank or Treasury making money, but it is very, very different. Our country’s Department of Treasury, for example, receives authorization from Congress to both issue Sovereign Bonds (Debt Financing) and print the currency. Our Central Bank, The Federal Reserve, has been utilizing QE since 2009. They have ‘created’ the money and used it to purchase bonds issued by the Treasury. The Treasury pays the interest on the bonds to all bond holders, including the Federal Reserve. Our Fed, however, is not allowed to keep this interest paid, and thus must remit it back to the Treasury. Thus the cost of servicing outstanding Government Debt isn’t just lower because of the interest rate, but also because of this remittance. When the bonds mature the Treasury will pay off the Fed and then Fed may then electronically ‘delete’ the money they previously created.
QE bonds purchases in many of the countries utilizing it have been of their own Sovereign Bonds. It first began with shorter dated bonds, but then shifted to those with a longer maturity. The BOE this time joined the likes of other SCB’s like the European Central Bank (ECB) and the Bank of Japan (BOJ) in their purchase of Domestically Issued Corporate Bonds. BOJ has taken QE a big step even farther in the last year and is actually purchasing Japanese Stocks via Exchange Traded Funds (ETF’s).
These actions by the BOE and the other SCB’s in the world are truly ‘experimental’. It has never been done before and both the predictable and unpredictable repercussions of it are not understood. And yet they continue to engage in it because the impact of lowering interest rates is not improving economic growth as much as the SCB’s would prefer.
My opinion on these actions is such that the Financial Crisis of 2008-2009 scared the SCB’s so bad that they will do anything and everything to prevent another one. i.e QE Infinitum, Greek Bailout, et al. Not knowing if the next economic downturn will be just a ‘regular’ recession or another ‘Great Recession’ is inciting them to take actions in avoidance of the latter.
I am also wondering if perhaps the lack of ‘desired effect’ of lower interest rates on Economic Growth is not because lower interest rates are not working, ‘Liquidity Trap’, but perhaps because of other extenuating Global causes that are not directly being controlled by either the SCB’s of the world or their respective governments.
Please see the July 1 2016 Market Minute for my comments on Negative Interest Rates and ‘Liquidity Trap’.