Saturday, October 20, 2012

Who believes central bankers?

Who believes everything a central banker says? Does Mr. Market swallow everything a central banker tells him without question?

Consider, for example, the issue of quantitative easing as money printing. On October 1, 2012, Ben Bernanke gave a fiery speech in defense of the Fed's monetary policy. In particular, he said that the Fed is not printing money with its QE programs, merely temporarily holding Treasury securities. The Fed will shrink bloated balance sheet by either selling Treasuries or let them mature at some appropriate time in the future [emphasis added]:
By buying securities, are you "monetizing the debt"--printing money for the government to use--and will that inevitably lead to higher inflation? No, that's not what is happening, and that will not happen. Monetizing the debt means using money creation as a permanent source of financing for government spending. In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size.
Bernanke is technically correct in that the Fed hasn't cancelled Treasury debt but "temporarily" holding them. But how credible is that exit strategy? Does anyone really believe that the Fed will normalize its balance sheet in the next few years?

The next logical step is the act of money printing. Gavyn Davies, writing in the FT, discussed the option of actually cancelling debt held by central banks:
One radical option which is now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely.
If this was to become a serious option, would the gold market freak out or is this event already discounted by the market because the Fed's exit strategy is not credible?

How credible are central banker statements?
The real question is, "How credible are central banker statements?"
Here is a real-life case of how the markets reacted to central bank actions that should have been discounted long ago. Last week, Bank of Canada governor Mark Carney turned more dovish and hinted that the BoC would not be raising interest rates in the near future.

Duh! Was that a surprise? Would the BoC actually buck the tide by raising rates when global central banks are undergoing an easing/QE cycle?
Apparently, the answer was yes, it was a surprise, according to news reports:
Some currency watchers attributed the loonie’s latest weakness to a speech Monday by Bank of Canada governor Mark Carney that was notable for what he didn’t say and interpreted as a more dovish tone toward the possibility of interest rate increases.

Carney did not include in his speech an often-repeated line that “modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”
Here is how the CADUSD exchange rate acted in the wake of the Carney speech:  
  Who believes everything a central banker says? Apparently Mr. Market does no matter how outrageous the statement is. It is just amazing.           Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

No comments: