Transcription of Finance News Network Round Table Discussion with Antares Fixed Income Fund investment manager, Ken Hyman and portfolio managers, Mark Kiely and Tano PelosiHas QE run its course? After a period of heightened market volatility, Ken Hyman, Tano Pelosi and Mark Kiely from Antares Fixed Income look at what a lower reliance on monetary policy may mean for markets.
Ken Hyman: Guys, at our last discussion we talked about the prospects of the rate hike from the Fed and also, some of the risks that possibly were building up in the markets, and what could go wrong. For two years, all players in investment markets have been fixated on QE and monetary policy. But over the last few weeks, something has been changing. The rhetoric has changed and micro pricing is changing a little bit. What’s happening – Mark?
Mark Kiely: I think markets are starting to question whether monetary policy is actually getting to the point, where it’s actually pushing against a string. We had the Bank of Japan meeting six weeks ago, late July, and they came out and pretty much underwhelmed the market with its response, with regard to additional QE. They also announced that they would be doing a comprehensive assessment of monetary policy, QE and effectiveness of QE with negative rates. So putting a bit of a question mark out there, as to whether the policy’s working.
More recently, last week we had the DCB Bank come out and also underwhelm markets, with regards to what they did. So I think the markets are starting to wonder if central banks are still as committed to supplying the juice, you might say, that keeps investment markets inflated. And so that’s obviously putting the jitters more recently in the equity market, and a little bit more steeply in the bond market of late.
Ken Hyman: Tano, your thoughts?
Tano Pelosi: It really comes down to over five or six years of quantitative easing across most of these jurisdictions. The central banks are really undershooting on their key objective, which is inflation. They’re trying to get inflation up to a certain level, and it’s really because what’s driving that is other factors – not just what moderate policy can control. These are supply related factors and weakness in productivity. So moderate policy is performing its function, but it needs help from other areas.
Ken Hyman: I would add to that that buying bonds and getting the yields down to negative interest rates are having significant, unintended consequences. We know that banks really struggle to make a profit. In fact they lose money when they go to negative interest rates. We’re seeing that in the earnings. And we’re getting strong feedback from large investors in Japan and the pension funds of life companies. They’ve been telling the BOJ directly that they cannot invest, and they will not invest. Japanese Post Bank won’t invest at negative interest rates. So the pressure is coming from traditional investors in markets that they’re resisting as well. So chaps, what are the different levers that the authorities can pull, if it’s just not monetary policy?
Mark Kiely: We’ve obviously seen a lot central bank activity across the entire yield curve, and they’ve driven the yield curve down structurally across the entire curve. And they’ve been the big buyer I guess, in that market. And as you say, that’s put a lot of pressure on life companies, pensions, as well as the banking sector itself with regards to their investments in these longer bonds, at often-negative yields now, particularly in Europe and Japan. And that’s hurting their investment earnings and therefore, hurting their profitability. And also probably constraining their ability to lend and therefore, the usual credit creation cycle.
So I think all that lends itself to put question marks, as to whether negative interest rate policy is actually working, whether they can continue with it. But particularly at the back-end, should 30-year rates be as low as they should or does that create bubbles, or does it sort of create misallocation of resources. So I think that’s been questioned, I think the other one that we’ve spoken about before is fiscal policy, as well as structural reform and things that may be done in that space as well, which is obviously very topical at the moment.
Ken Hyman: Tano?
Tano Pelosi: On moderate policy, one of the key benefits has been through what they call, the follow balance approach and it’s really given rise to positive wealth effects. That’s primarily how it’s worked, but ultimately there’s a trade-off here and the trade-off is financial instability. So we’re seeing a bit of that at the moment, given this protective put that’s coming from central banks, and this heightened sensitivity of the market to what central banks do, or not do, in this case. So short of that, I think fiscal policy can play a key role and then ultimately structural reforms across many of these areas, I think will be far more important.
Ken Hyman: So just on fiscal policy, we’ve been talking for a long time that fiscal needs to kick in. But we’re getting a lot of feedback from the key decision makers. Like after the recent G20 meeting, the communiqués that came out were talking about ‘monetary policy can only go so far’, and fiscal policy needs to kick in. But fiscal policy is much more political. With monetary policy, you can outsource it to your central bank and they do what they have to do. But with fiscal policy, you need consensus.
Japan seems to have an easier run; I think the UK has an easier run in fiscal policy. Europe – it is going to be very very difficult, just by virtue of the contract and the reluctance to have fiscal transfers between surplus and deficit countries etc. And then in the US, both candidates for the election are talking openly about increasing fiscal spending.
Now this week ahead, it could be a huge week. Markets are bracing themselves, there’s an excitement around, there’s excitement in pricing, we’ve a lot of volatility. You know the VIX has gone from about 8 to 18 – a fair bit’s happening. I’ll just flag that the FOMC are meeting, late in the week and we’re going to get outcomes in Australia on 22nd September. But possibly more importantly on 20th and 21st September, the Bank of Japan are having their follow-up meeting, where they are going to make the long awaited decisions on maybe some tweaks to their QE program. I think markets are bracing themselves for volatility. How do we feel -- Aussie opportunities -- I mean what’s the best bet for the coming week?
Mark Kiely: I guess there’re always opportunities. I guess it’s hard to know exactly what sort of announcements we’re going to see coming out. The market’s taken the view that maybe the Bank of Japan is going to wind back its long bond purchases. And that puts a little bit of pressure on the back-end of the Japanese bond market and globally, markets as well. We’ve obviously seen, on the back of that, I guess the ECB announcements (or lack of announcements) late last week, caused a bit of a mini two-day taper tantrum, with regards to equity prices and bond prices to some degree as well.
So the market has actually shifted its thinking and some of that’s been price in the market. The question mark is to whether the central banks will deliver market expectations or not, and that’s always a hard one to play. But I think to your point, the market is playing around these volatility points, which is basically now central bank meetings and outcomes of central banks. Which all gets to the point of central banks have been the big providers liquidity to market, for so many years now. The question is now are they going to continue to be that way, or are things going to change? So volatility’s probably the main thing I can say,that I think we’re going to see.
Ken Hyman: Tano?
Tano Pelosi: I guess this is one of the side effects of QE. Central banks help supress volatility in financial markets. To get your returns, you see more leverage, bigger bets and then, when the cat’s out of the bag and you see more volatility rise, it begets more volatility. Then there’s a de-leveraging that has to take place. So it starts to feedback on itself and there’s negative feedback loop. So it’s hard to know where it actually stops, but I would say, at the end of the day, the question you need to sort of resolve for yourself is – has the fundamental backdrop changed?
Ken Hyman: Exciting week ahead no doubt and I think we’re bracing ourselves, looking forward to having a follow up discussion most probably in a few weeks time.
Ends
