Central Banks: Still Early Days

Mid Week Bond Update

Central Banks: Still Early Days

The world's biggest central banks are all easing monetary policy. The biggest impact should be in 2020 -- but there are already signs of change.


With the Federal Reserve and the European Central Bank (ECB) having resumed the expansion of their balance sheets and commitment to keep rates low, the world’s five major central banks1 are now on roughly the same page with respect to monetary policy – and have now been rowing in the same direction since early 2019.  
 

Big 5 Central Banks: 12 Month Balance Sheet Changes

Chart courtesy of Brandywine Global.  Source: Macrobond, as of 11/30/2019. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Monetary policy is generally seen as having a lag in its impact on the overall economy, and Brandywine Global observes that so far, the dollar has indeed stayed stubbornly strong while leading economic indicators in the major developed economies have remained muted.  

However, the big central banks' moves have improved leading economic indicators for smaller and emerging market (EM), notably in Mexico, Turkey and Australia.

The U.S. economy, of course, has also benefited from fiscal stimulus, in the form of a tax cut and increased deficit spending. The lessons from that success are not lost on Europe's policy makers, who are actively considering similar moves to nurture their own nascent turnaround.


On the rise: IMF worries on sub-Saharan African Governments' Debt

Strengthening prices have boosted the economies of commodities-driven economies in Africa at the same time as record low interest rates have driven the cost of borrowing downward. 

The result, according to a November report by the International Monetary Fund (IMF), has been to put the government debt of 20 out of the 54 countries in Africa "near or at distressed levels" – meaning that in the IMF's estimate, those countries may have difficulties making good on their expanded debt obligations. 

In 2019 to date, governments in Africa have borrowed about $26 billion in international markets, roughly the same as in 2018, as the demand  for returns in a negative-yield world drove up lending – especially in so-called hard-currency bonds, those issued in euros, dollars, and yen.   

But with current commodity prices still strong and interest rates still low, it’s little surprise that the African Development Bank considers African countries' debt-to-GDP ratio to be still "well within acceptable limits".
 

On the slide: Cash levels at major U.S. banks

As the end of 2019 approaches, the largest U.S. banks are reducing their levels of cash on hand. As of December 10, 2019, top banks now hold about 31% of their total "liquidity pools" in the form of cash, compared to 2018's 41.2% and 2017’s 42.6%. Instead, the banks are choosing to hold U.S. Treasuries. 

That's what's behind the increased demand in the repo market in recent months, as transactions that used to be settled in cash are finding banks to be increasingly reluctant to lend it overnight.

The crunch is an unanticipated result of post-2008 regulations designed to strengthen bank balance sheets by discouraging bank’s own dependence on the repo market for short-term cash. So banks’ new balance sheet strength has paradoxically generated decreased stability in the overnight market, with the Federal Reserve stepping in to absorb the extra demand by boosting its own lending – and thereby increasing its own balance sheet rather than that of the banks.

 

Note: The year for all dates is 2019 unless otherwise indicated


1 The Federal Reserve (Fed), European Central Bank (ECB), Bank of England (BoE), Bank of Japan (BoJ), Peoples’ Bank of China (PBoC).

 

Definitions:

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

The International Monetary Fund (IMF) is an international organization of various member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.

The African Development Bank Group (AfDB) or Banque Africaine de Développement (BAD) is a multilateral development finance institution. The objective of the (AfDB) Group, which includes the African Development Bank (ADB), is to spur sustainable economic development and social progress in its regional member countries, thus contributing to poverty reduction.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

Repo is a form of short-term borrowing for dealers in government securities.

The repo market refers to the market for short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day.

A liquid asset is cash on hand, or an asset that can be readily converted to cash. An asset that can readily be converted into cash is similar to cash itself because the asset can be sold with little impact on its value.

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