RBA joins Central Bank slash, bond holders earn

Bond investors have just had a new world opened to them; one where they benefit from central banks aggressively cutting rates and sliding commodity prices.

The recent panic moves from central banks around the world feel like useless attempts to hold back the disease of deflation crossing their borders. We know this is only the start of their efforts, because once deflation takes hold and starts affecting expectations, it will be very, very difficult to eradicate.

There may be even bigger problems down the line for developed economies with high debt loads like Japan, the United States and the United Kingdom. Falling inflation leads to climbing real interest rates.

 

Interest rate cuts closer to home

The Reserve Bank of Australia’s February cut this morning (as we forecast this morning here) wasn’t at all surprising given recent domestic inflation numbers came out right on its inflation target.

Going forward we expect the language to change to an outright cutting bias – particularly as pressure from the Bank of Canada plays on minds of the Reserve Bank board members.

Which central banks are panicking?

The desperation of the central banks is showing; monetary easing has been widespread, and in many cases not expected at all by the market.

  • European Central Bank after introducing negative interest rates, the bank then over delivers on their easing program, promising to buy over 1 trillion euro of ‘stuff’ in 18 months.
  • Bank of Canada cuts an unexpected 0.25% citing the effect of a falling oil price on economic growth and weak inflation.
  • Central Bank of Turkey cuts an unexpected 0.50% due to falling inflation, with more cuts likely in the near future.
  • Danish Central Bank delivers three (yes, three) interest rate cuts in two weeks, sending rates into negative territory.
  • Monetary Authority of Singapore changed their currency peg slope for the Singapore Dollar again on the back of lower inflation.
  • Reserve Bank of India while delivering good results on growth and the current account deficit, also unexpectedly cut rates owing to the effect of the oil price.
  • Bank of Japan and the People’s Bank of China cut rates by 0.25% to 2.75% in order to stem the fall of a very weak property market.

Make no mistake – these are panic moves to halt the spread of deflation and my bet is they won’t be successful.

 

My award for the most jaw-dropping central bank decision

Everything mentioned so far has been pretty vanilla compared to the Swiss National Bank announcing (with no warning) that it will enforce a cap on the Swiss Franc against the Euro – which ultimately led to 35% appreciation of the Franc that same day.

In my opinion abandonment of the cap represents a pretty poor choice. Not only have they killed their watch, cuckoo clock and chocolate export industries with the rise in the currency but negative rates will kill the huge financial industry, too.

Unfortunately this wasn’t the only crazy thing the Swiss National Bank woke up and decided to announce that day. Since it knew a stronger currency would plunge the country further into deflation and destroy the competitiveness of exporters it decided to cut interest rates on sight deposits to -0.75%.

This leads us to question who will be next? The Bank of Japan is the first one that springs to mind even if the idea had previously been investigated and discarded.

 

Why the US Federal Reserve won’t make a move

The pressure on central banks has clearly been intensified through the fall in the oil price, the collapse of copper and impending collapse of other commodities such as softs. This weakening commodity complex is forcing the US dollar higher, compounded by central bank divergence making these trends even stronger.

The US dollar has entered a vicious cycle where its appreciation causes more commodity falls which in turn causes the US dollar to strengthen and so on. It almost doesn’t matter what the US Federal Reserve does in this environment, but hiking rates will only make the appreciation stronger and more damaging.

That is why we expect no rate rises from the US this year, and the next move to be another quantitative easing package sometime next year.

 

What’s an investor to do?

We are on the verge of a clear regime change in how the world thinks about monetary policy and the recent events will be only a teaser to what we will see over the next 10 years.

Bond yields may appear low, but these recent events have reinforced why you should own more bonds than you already do, and own as much US dollars as possible.

 

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