Central banks should know by now that you can’t have negative interest rates with low bond yields and strong growth. One or the other.
Central banks have chosen low bond yields at any cost, despite all the evidence of stagnation ahead. This creates enormous problems and perverse incentives.
Interestingly, European markets declined sharply after the European Central Bank sent the ultimate dovish message, a change in its inflation target that would allow the central bank to exceed its 2 percent limit without change of policy. What does it all tell us?
First, that the placebo effect of stimulus packages shows a shorter impact. Trillions of dollars spent create a small positive effect that lasts for less than three months, but leaves a massive trail of debt behind.
Second, central banks are increasingly hostage to governments that simply won’t curb deficit spending and implement structural reforms. The independence of the monetary authorities has long been questioned, but now it’s become clear that governments are using loose policies as a tool to abandon structural reforms, not to buy time. No developed economy can tolerate a slight increase in government bond yields, and with sticky inflation in non-replicable goods and services, this means stagnation ahead with higher prices, a bad omen for the overall economy.
Third, and more concerning, market participants know this and take incremental levels of risk, knowing that central banks won’t taper, which leads to a more fragile environment and extreme levels of complacency.
So-called value sectors have retraced in equity markets, which shows that the recovery has been priced and that the risk ahead is weakening margins and poor growth, while the traditional beneficiaries of “low rates forever” have soared to new highs.
Despite rating companies’ concerns about the rising figure of fallen angel debt, there’s extreme complacency among investors looking for yields, and they’re buying junk bonds at the fastest pace in years, despite a rising number of bankruptcies.
Central banks justify these actions based on the view that inflation is transitory, but ignore the risks of elevated prices even if the pace of increase in those prices slows down. If food and energy prices rise 30 percent then fall 5 percent, that’s not “transitory” to consumers who are suffering the above-headline increase in prices of things they purchase every day, a problem that occurred already in 2020 and 2019. The most negatively affected are the middle-low income and poor classes, as they don’t see a wealth effect from the rise in asset prices.
Sticky inflation and misguided loose fiscal and monetary policies aren’t tools for growth, but for stagnation and debt.
So far, central banks believe their policies are working because equity and bond markets remain strong. That’s like giving more vodka to an alcoholic because he’s not died of cirrhosis yet. Low bond yields and high levels of negative-yielding debt aren’t signaling monetary success, but are evidence of a deep disconnection between markets and the real economy.
Central banks have already stated that they'll continue with ultra-loose policies, no matter what happens to inflation in at least a year and a half. For consumers, that’s a lot of time for weakening the purchasing power of salaries and savings. Markets may continue to reward excess and high risk, but that’s not something that should be ignored, let alone celebrated. Extreme risk will be blamed for the next crisis, as always, but the cause of that extreme risk—perennial loose monetary policy—won’t stop. In fact, it will be used as the solution if there’s a market collapse.
Central banks should be tapering already, and if they believe that low sovereign yields are justified by fundamentals, let markets prove it. If negative nominal and real yields are justified by the issuers’ solvency, why is there any need for monetary authorities to purchase 100 percent of net issuances? Reality is much scarier. If central banks started tapering, sovereign yields would soar to levels that would make many deficit-spending governments shake.
Therefore, by keeping yields artificially low, central banks are also sowing the seeds of higher debt, lower productivity, and weaker growth—the recipe for crowding-out, overcapacity, and stagnation.
