ref :- "Bond investors are addicted to the stimulus placebo" , Markets Insight by Tommy Stubbington, The Financial Times, Markets & Investing
It hasn't always seemed that way (see "Greenspan Put" etc) , but theoretically at least central bank mandates have absolutely nothing to do with supporting asset prices. The dual mandate of the US Federal Reserve targets sustainably high levels of employment and control of inflation. The mandate of the European Central Bank (ECB) is even simpler ..... nothing specific about employment (though everything's connected, of course), and one simple obligation to control price inflation in the Eurozone for which the current target is an annual rate of just under 2.0% .
Of course we know that it's been anything but simple . In fact, over the last decade much of the ECB's energy on that front has been aimed at staving off deflation. They made some mistakes along the way but by implementing radical new monetary policies (ultra-low / negative rates, massive Quantitative Easing programmes of bond purchases to lower yields) they managed that, but positive inflation has rarely threatened 2.0%, and is on its way lower again at just under 1.0%.
That's why when outgoing ECB president Mario Draghi started intimating in June that further stimulus was on the way , particularly a resumption of QE, bond investors were happy to pile in yet again. For those who are not buying bonds as long-term holds, purchasing debt with negative yields is no problem if you expect central bank stimulus to push yields even lower -- for as we all know as yields fall , prices rise and a good turn is there to be made.
The irony, if that's what you want to call it, is that these same market players have been pricing a closely-watched indicator of future inflation -- the 5yr / 5yr forward inflation rate, which measures what expectations are for the average annual inflation rate for the five years starting in five years time -- at 1.11 %, well below the target of 2.0%. In effect, what they are saying is that they recognise the ECB's efforts to push yields lower in order to encourage some inflationary pressure, are happy to go along for a profitable ride, but have very little expectation that it will be successful.
There are widely contrasting views about the ECB's policy actions, even within the institution itself . Some applaud the decisive addition of more stimulus to counter the downturn in expectations for inflation and growth. Others say it's gone too far, and carries grave dangers for banks, insurers, pension funds and savers, whilst increasing the chances of asset bubbles etc. Wherever you stand on that argument, increasing numbers of commentators are signing up to the view that easing monetary policy from these already super-easy levels is having less and less of an effect. And if that's the case, why keep doing it ?
Mr Draghi has pointed out the global geopolitical and economic headwinds that monetary policy in the Eurozone is having to deal with. But since monetary policy is easing almost everywhere on the planet, one could equally, argue that investors are losing faith in the power of central banks wherever you look.
Whether it's true or not, you could wait an awfully long time to hear a central banker actually admit that they are running out of ammunition. Apart from anything else, it could have some regrettable market consequences. But some might see Mr Draghi's most forceful plea yet for Eurozone governments (and we can be sure he means Germany in particular) to start spending as a tacit admission that central banks cannot do it on their own. The monetary stimulus must be accompanied by fiscal stimulus.
The thing about fiscal stimulus is that at it's most simplistic it entails governments borrowing and spending. When there were late-Summer suggestions that Germany might abandon its strict commitment to balanced budgets, which would mean greater supply of newly-issued bonds, prices wobbled. It was not to be of course, and prices rallied and yields fell once more. But IF a German government were to change this cornerstone of their fiscal discipline in place since the financial crisis, one could expect a severe, even violent adverse reaction in bond markets. It would certainly be dramatic, but the fact that there seems to be no end to the demand for highly-priced, negative-yielding bonds gives us a pretty clear illustration of just how unlikely the market thinks such a move is.
Anyway, where to now ? Those who defend the aggressive easing policy path taken by the ECB from more hawkish voices including central bankers from Germany, the Netherlands and Austria will point to this : it's all very well saying that ECB policy has failed in getting inflation back up to 2.0%, but where would inflation be if the central bank hadn't acted the way it has ? Still facing deflation ? It's a fair point, but the increasing calls for higher rates suggest that the tide may be slowly turning against the current approach on the grounds that it's achieved as much as it can.
We'll see if Christine Lagarde, Mr Draghi's successor, goes even further down the easing path. If she does, expect those hawkish voices to get much louder .... and you might also expect more credence being given to a nice little conspiracy theory that Mr Stubbington brings to our attention :
The ECB continues lowering rates and yields to make things so painful for German savers that Berlin is forced to backtrack on its commitment to balanced budgets and embrace fiscal stimulus.
Mmm ..... as theories go, that's a doozy but if true it would be pretty nasty for bond investors who would have to be mighty nimble ..... and desperately dangerous for an ECB already accused of being over-politicised.