Negative mortgage rates in Denmark. Sub-zero yields on 10-year corporate bonds from Nestle SA. A 100-year Austria bond trading at more than twice its face value. Record low yields on 30-year Treasuries. For fund managers trying to navigate the fixed-income universe, the bond market’s reaction to the prospect of a recession makes life more treacherous every day.
Investors see a second Federal Reserve interest-rate cut at its next meeting on Sept. 18 as a certainty, based on prices in the interest-rate futures market. But it’s the European Central Bank that appears to be facing the more difficult policy decision, given that its key interest rate is stuck at -0.4%.
As the chart above shows, futures contracts in the euro zone have dramatically repriced since the beginning of the month. Traders are anticipating that borrowing costs will drop even further into negative territory and that the ECB will resume its quantitative easing program.
But some investors are questioning how effective the central bank’s effort to gobble up more of the outstanding debt in the government bond market can be when yields have already reached record lows.
For Philipp Hildebrand, vice-chairman of BlackRock Inc., the ECB is already out of ammunition – which means investors should indulge in some more magical thinking about what comes next in the list of unconventional policy measures.
“We’re going to see a regime change in monetary policy that’s as big a deal as the one we saw between pre-crisis and post-crisis, a blurring of fiscal and monetary activities and responsibilities,” Hildebrand told Bloomberg Television’s Francine Lacqua last week.
BlackRock has just published a paper detailing what it expects the guardians of monetary stability to do next. Here’s the key recommendation from the paper, which is entitled “Dealing with the next downturn: From unconventional monetary policy to unprecedented policy coordination.”
An unprecedented response is needed when monetary policy is exhausted and fiscal policy alone is not enough. That response will likely involve “going direct”: Going direct means the central bank finding ways to get central bank money directly in the hands of public and private sector spenders.
What’s incredible about the BlackRock policy prescription is that three of the paper’s four authors are former central bankers who now work for the asset manager. Hildebrand is the former head of the Swiss Central Bank, Stanley Fischer did stints at the Federal Reserve and the Bank of Israel, while Jean Boivin is ex-deputy governor of the Bank of Canada.
Think about that for a second. Three former central bankers – not academics, not professors, not theoreticians – are saying that central bankers are out of ammunition, and that politicians won’t be able to muster enough fiscal firepower to resuscitate growth. These are people who’ve been at the coalface of implementing monetary policy. So the rest of us need to pay attention.
As my Bloomberg Opinion colleague Brian Chappatta points out, BlackRock’s publication is timed to coincide with the annual Kansas City Fed’s Economic Policy Symposium that kicks off on Thursday in Jackson Hole, Wyoming. While that gathering has the anodyne title of “Challenges for Monetary Policy,” the size of the task currently facing the world’s central bankers suggests the meeting could be one of the most important in recent years.
Concern about the outlook for growth is mounting. Even the German government, which has resisted the temptation to take advantage of ultra-cheap money to boost spending, is readying a package of fiscal measures to counter a deep recession, my colleague Birgit Jennen at Bloomberg News reported Monday. But improving energy efficiency, encouraging hiring and increasing social welfare payments may prove too little, too late.
In the euro zone, BlackRock suggests the ECB could adopt a plan first proposed in 2016 by Eric Lonergan, a fund manager at M&G Prudential, in which the central bank offers zero-coupon loans to each adult citizen. While Lonergan is explicitly in favor of helicopter money, the BlackRock paper sees a risk of it creating runaway inflation:
History is littered with examples of how central bank money printing leads to runaway inflation or hyperinflation. Yet there is little experience in using helicopter money to generate just-enough inflation to achieve price stability. History as well as theory suggests large-scale injections of money are simply not a tool that can be fine tuned for a modest increase in inflation.
BlackRock’s tweak to the helicopter money proposal, popularized by former Fed Chairman Ben Bernanke in a 2002 speech, involves establishing a permanent “standing emergency fiscal facility” that would only used in extremis, and in combination with monetary and fiscal policy becoming “jointly responsible for achieving the inflation target.” It would come with “a predefined exit point and an explicit inflation objective.”
Both of those latter constraints are likely to prove as problematic for BlackRock’s proposal as they have for the current unconventional policies pursued by central banks. Exiting quantitative easing and returning interest rates to more normal levels have both turned out to be far more difficult than expected; and explicit inflation objectives are useless when prices stubbornly refuse to rise.
Nevertheless, bond investors have definitely caught wind of something shifting in the monetary-policy air, and have reacted by extending the list of never-seen-before happenings in the debt market. Maybe the next thing will turn out to be a helicopter dropping money – with Christine Lagarde, the incoming president of the ECB, in the pilot’s seat.
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Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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