This Game’s Almost Over: Central Banks Are Running Out Of Options

Lance Gaitan

Going into last week’s Fed meeting, the general consensus was that they would not raise rates. When they hiked rates by a quarter point in December, they projected there would be four additional quarter-point raises in 2016. That’s starting to look fishy as we’re almost a quarter of the way through the year and there’s still no hike.

Sure enough, the Fed left rates unchanged as expected last week, and revised their rate expectations lower through 2016. Now, they anticipate only hiking another half point by the end of the year.

But the most interesting part of their policy statement had to do with why they lowered their projections. Rather than citing economic developments here at home as a “data dependent” Fed should do, they referred to global economic developments that are posing risks.

That tells me that the Fed is really just reacting to global currency maneuvers. Right after the Fed statement announcement – where they projected to have only two rate hikes this year, down from four – the U.S. dollar fell sharply against foreign currencies.

It’s going to be hard for the Fed to raise rates here while foreign central banks are easing and going negative with their rates. Just before the Fed and the Bank of Japan (BoJ) met, the European Central Bank (ECB) increased QE and moved rates further negative. And the BoJ adopted negative rates in their January meeting.

Since the Fed and the BoJ announced monetary policy last week and the ECB the week before, it’s probably a good time to look at what’s ahead for central bankers, especially the Fed.

The BoJ didn’t change monetary policy at their meeting last Tuesday. They were probably a little gun-shy after having their last action backfire when they announced a surprise negative interest rate move. They wanted to weaken their currency and move stock higher and the opposite happened.

Then last week their currency got even stronger. The original thought was that by not increasing rates, the Fed wouldn’t pressure the yen. But the dollar fell against the yen and other currencies, making them stronger.

That’s when the BoJ intervened (again) by directly selling the yen in the open market, hoping to offset its earlier strength.

And the currency games continue…

The BoJ is probably running out of policy options. Despite decades of currency intervention, quantitative easing and now negative rates, they have failed to spur economic growth, consumer spending and inflation. Is this finally the end?

Japan started their monetary easing and quantitative easing decades ago. The Former Fed Chair Ben Bernanke followed suit in the wake of the financial crisis in 2008. Europe’s central bank tagged along later. China has been playing currency games for years.

While all of this central bank tinkering has affected some asset prices and currency valuations, there is no proof that it’s helped spur consumer spending, GDP growth or exports. In fact, China’s exports fell 25% over the last year while Japan was down 13%! Ouch!

Here at home, the Fed can claim that inflation is on track to hit 2% in the next year or so and can brag about low unemployment all it wants.

But those actually participating in the labor force have shrunk to levels not seen since the 1970s. The majority of the jobs growth has been in low-paying jobs, and wage growth has been non-existent.

Another important measure of our economic health is the manufacturing sector. The Institute for Supply Management’s (ISM) Manufacturing Index read below 50 for five straight months. That means an overall decline in orders, exports, employment and a lack in confidence in the business outlook. That’s deflation, folks.

Just like elsewhere in the world, there is no proof that central bank monetary policy actually works. It hasn’t helped to turn the tide in Japan, Europe, China or here at home. So why do central bankers keep doing something that they must know doesn’t work?

QE, bond buying, asset purchases, zero interest rates, negative interest rates, reserve selling, currency selling – all it achieves is to temporarily move some asset prices and currency valuations. But it has not spurred economic activity, employment, wage growth or even inflation.

Central banks are fighting losing battles. From aging and declining populations in Japan and elsewhere, to business cycles and bubbles, they’re dealing with forces beyond their control.

We are near the end though. Monetary policy tools have less and less impact. Central banks are running out of bonds to buy, interest rates can’t go too far below zero and outright currency manipulation will eventually lead to trade wars.

When central banks have shot their last policy bullets, maybe business will begin to normalize. Eventually, economies and wages will grow and lead consumers to spend, and we’ll reach a normal business cycle.

In the meantime, expect there to be plenty of market volatility, which means there will be plenty of opportunity to make money! Overreaction in long-term Treasury bond prices is one way Treasury Profits Accelerator readers profit. Click here to learn more about this system.

Lance Gaitan
Editor, Treasury Profits Accelerator