By Paul-Martin Foss
The years during and after the financial crisis saw a consensus of monetary easing among central bankers around the world. The Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan all engaged in loosening their monetary policy, creating trillions of dollars worth of new money in an attempt to boost their economies. None of them wanted to be the only one not easing monetary policy, and none of them wanted to the first to return to “tighter” monetary policy. But are we beginning to see this easing consensus breaking down?
At last month’s World Economic Forum in Davos, Switzerland, UBS Chairman Axel Weber stated that he believed the momentary divergence between the Federal Reserve, which is beginning to slightly tighten its monetary policy, and the ECB, which is talking about further easing, is behind volatility in markets, but he didn’t see the divergence as being permanent. Reserve Bank of India Governor Raghuram Rajan stated that he believed that monetary stimulus had run its course. Any further stimulus would risk further exacerbating already inflated asset prices. Was this a shot across the bow of the Western central banks? Admittedly the Reserve Bank of India isn’t the world’s most influential central bank, but India isn’t exactly a pushover either. If Rajan’s comments were to be viewed as throwing down the gauntlet, daring other central bankers to continue monetary stimulus, Bank of Japan Governor Haruhiko Kuroda appeared to take up Rajan’s challenge last week, engaging in another round of monetary easing that took world markets completely by surprise. How will other central banks, and especially the Federal Reserve, react to Japan’s move?
Kuroda’s move really puts the Federal Reserve in a tough position. The ECB has hinted at further easing in March, the Bank of England so far seems to be staying put with its easing measures, so the Fed is now the odd man out among the major central banks. While there may or may not have been outright coordination between the major central banks and their policies of quantitative easing during the years following the financial crisis, the fact that all of them were easing roughly simultaneously prevented sudden major shifts in the exchange values of their respective currencies. Now that the Fed has signaled a return to a more normal monetary policy and a series of interest rate increases this year, it is clearly out of step with its international counterparts. Since the “strong” dollar had been identified as one reason for the Fed to take its time in raising rates, and further weakening of the yen and euro through more monetary stimulus should lead to a stronger dollar, will these actions on the part of the Bank of Japan and the ECB cause the Fed to rethink its rate hikes?
The Fed was already facing markets that have performed terribly this year, ongoing turmoil and uncertainty in China surrounding its economy and currency, and now another blow in the form of more easing by foreign central banks. Does the Fed have the willpower or, more importantly, the ability to swim against the stream by raising rates? Federal Reserve Chairman Janet Yellen will testify to Congress next week, so expect her to face questions about the Fed’s interest rate policy going forward, but at this point it would be highly unlikely that the Fed will raise rates at its mid-March meeting. There will also be two more monthly releases each of inflation and unemployment data before then, so those numbers could be influential too, but the year is still young. It remains to be seen by December whether the Fed will stick to its guns and normalize policy, engaging in the divergence which some on Wall Street fear, or if it will kowtow to the desires of financial markets that have become addicted to easy money and cheap credit.