The end of the monetary illusion magnifies shocks for markets

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Central bankers are no longer the circuit breakers for financial markets.

Monetary-policy makers, market saviors the past decade through the promise of interest-rate reductions or asset purchases, now lack the space to cut further or buy more. Even those willing to intensify their efforts increasingly doubt the potency of such policies.

That’s leaving investors having to cope alone with shocks such as this week’s rout in China or when economic data disappoint, magnifying the impact of such events.

“The monetary illusion is drawing to a close,” said Didier Saint Georges, a member of the investment committee at Carmignac Gestion SA, an asset-management company. “With central banks becoming increasingly restricted in their stimulus policies, 2016 is likely to be the year when the markets awaken to economic reality.”

Even against the backdrop of this week’s market losses, Federal Reserve officials signaled their intention to keep raising interest rates this year. Those at the European Central Bank and Bank of Japan ended last year playing down suggestions they will ultimately need to intensify economic-aid programs.

They have only themselves to blame for becoming agents of volatility, according to Christopher Walen, senior managing director at Kroll Bond Rating Agency Inc.

He told Bloomberg Television this week that officials’ willingness to keep interest rates near zero and repeatedly buy bonds and other assets meant they became “way too involved in the global economy” and should have left more of the lifting work to governments.

The handover to looser fiscal policy now needs to happen if economic growth and inflation are to get the spur they need, said Martin Malone, global macro policy strategist at London- based brokerage Mint Partners.

“Major economies have exhausted monetary and foreign- exchange policies,” he said. “Government action must take over from central-bank policies, triggering more confident private- sector investment and spending.”

The influence of central bankers was underscored by a report this week from currency strategists at HSBC Holdings Plc, which calculated foreign-exchange markets are more sensitive to interest-rate decision-making than at any time in the last 15 years.
 
“FX markets are likely to remain hypersensitive to rate expectations until we are past the current era of extremely accommodative monetary policy,” the strategists led by David Bloom wrote.
 
Even if more stimulus does end up being delivered by the ECB or BOJ, China’s increased willingness to devalue the yuan will blunt the effect of it by limiting declines in their currencies and pushing up bond yields as money exits China, according to George Saravelos, a strategist at Deutsche Bank AG in London.
 
“All of these natural market forces that have been suppressed and overwhelmed by money printing by developed-market central banks will likely assert themselves this year,” said Stephen Jen, founder of London-based hedge fund SLJ Macro Partners LLP. “My guess is that this will not be a tranquil year.”


Simon Kennedy
Bloomberg News

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