To taper or not to taper — and if so, how?
Those are the questions investors are asking with increasing urgency as they tire of endless monetary policy easing and as central banks seek to persuade governments to help take on the challenge of quickening global growth.
The world economy has “moved sideways”, Maurice Obstfeld, chief economist of the International Monetary Fund, said on Tuesday. “Growth has been too low for too long.”
“Tapering” is the inexact science of how central banks wind down programmes such as quantitative easing, either when economic conditions begin to render them no longer necessary or they reach the limits of their effectiveness.
As the US Federal Reserve discovered in 2013, the problem for policymakers is how to convey this message to a market mentally fixated on bond-buying without causing upheaval — which is how “taper tantrum” entered the financial lexicon.
Having navigated its path away from QE, the Fed has now moved beyond tapering and, after raising rates last December, is poised to do so again before the year is out. The market is now asking whether it is the turn of the Bank of Japan and the European Central Bank, both of which have added negative interest rates to their arsenal amid much criticism, to take the plunge and taper.
For investors dependent on mass bond-buying programmes, this question involves poring over policymakers’ pronouncements for clues about their long-term intentions. When ECB president Mario Draghi last month said the governing council had not discussed an extension of QE, he reignited debate about the effectiveness of its asset-purchase programme.
The BoJ is going through similar ructions. Two weeks after it announced changes to its monetary policy strategy, traders are still trying to determine whether they amounted to the start of tapering.
The uncertainty centres on the fact that just before the meeting, Haruhiko Kuroda, BoJ governor, was clear that the bank would not consider reducing monetary accommodation. Nevertheless, said Nicholas Smith, CLSA’s Japan strategist, “steepening the yield curve while leaving the short end untouched seems suspiciously like precisely that”.
Sean Darby, a strategist at Jefferies, said the BoJ’s comments were “suitably vague” and argued that the BoJ had, in effect, been forced to taper because its massive JGB buying programme had left it with a shortage of bonds to buy.
Japanese stocks: unloved and stuck in the shadow of Abenomics
The move, say traders, has allowed two clear schools of thought to emerge — one thinks that the BoJ’s move was, in effect, a tapering and another that does not but is guessing that the yen might trade for several months as if it were.
Shusuke Yamada, Japan head of FX strategy at Bank of America Merrill Lynch, said that while some market participants certainly had interpreted the BoJ’s move as the signal of a taper, the dollar-yen market had over recent months priced that in. The reason the yen had remained comparatively stable since September 21 was that the market had not left much room for a sudden repricing.
But Mr Yamada, who maintains his call that the yen will weaken in 2017, argues that the BoJ’s move was not a tapering. Instead, the move to control the JGB yield curve was a signal that it cares about the profitability of the financial sector and recognises that it is threatened by its negative interest rate policy.
If you think that monetary policy is transmitted by the financial institutions, said Mr Yamada, then the BoJ’s move should be interpreted as not a taper but one that smooths the way for it to continue with its easing programme.
The complexity is deepened, argue analysts at Nomura, because the yen’s movement against the dollar, euro and other currencies could spend the remaining months of 2016 in even greater thrall to Japan’s banks and life insurers and the calls they are now likely to make on what the BoJ’s latest move portends for the JGB market.
ECB holds fire on extending QE
The European Central Bank has signalled it will hold fire until the turn of this year before unleashing a fresh wave of stimulus, even as it inched down estimates for growth over the next two years.
The tapering question is not confined to the ECB and the BoJ. Norges Bank last month changed guidance on rates because of a stronger growth trajectory. It is now no longer planning for rate cuts.
Taper talk is changing market calculations. The Norwegian krone is 3 per cent higher since last month’s central bank announcement. Late on Tuesday, the euro erased its losses and bond prices fell on reports that the ECB was preparing the groundwork for tapering.
Andrew Balls, head of global fixed income at Pimco, suggested that central bank interventions were suffering diminishing returns and investors were underestimating the market jolts that tighter monetary conditions would create.
The ECB maintains that the governing council has not discussed the topics, yet investors have long been aware that, within the eurozone, QE remains a divisive policy and that, despite spending €1tn on government bonds in a bid to revive inflation and growth, targets are proving stubbornly hard to reach.
Whenever it comes, exiting QE will be as game-changing as its introduction.
“If there is going to be a withdrawal of stimulus, risk markets will turn lower and volatility will go up,” said Paul Lambert, currency manager at Insight Investment — and that might be enough to force an about turn from central banks.
“They will look at tapering with an option to untaper quite quickly,” Mr Lambert said. “A bit like taking the foot off the accelerator but not yet putting it on the brake.”