latamen
Central bank watcher: Rates in lockdown for longer

Central bank watcher: Rates in lockdown for longer

28-04-2020 | Insight

Central banks have stepped up to the plate by delivering significant amounts of easing. Our scenarios for central bank easing are now fully priced in, except in China.

  • Rikkert  Scholten
    Rikkert
    Scholten
    Portfolio Manager
  • Martin van Vliet
    Martin
    van Vliet
    Strategist and member of Robeco’s Global Macro team, Robeco
  • Bob Stoutjesdijk
    Bob
    Stoutjesdijk
    Analyst

Speed read

  • Federal Reserve keeps control of the curve
  • PEPP talk from the European Central Bank
  • A long road to lower bound for the People’s Bank of China

With the outbreak of the coronavirus hitting the global economy, central banks have stepped up to the plate by delivering significant amounts of easing. Official yields are now at or below zero for all developed economies, and asset purchases are surging.

Now also follow us on Instagram
Now also follow us on Instagram
Follow

Differences between central banks

Still, we see important differences between central banks. While the Federal Reserve Bank was able to cut rates by 150bps, the European Central Bank (ECB) and Bank of Japan (BoJ) kept rates unchanged at levels that were already sub-zero. All three central banks expanded their asset purchases, but while the Fed bought sovereign debt worth 7% of GDP in the space of six weeks, the ECB ‘only’ bought an equivalent of 1% of GDP.

We expect these differences in pace to be reduced. The Fed is scaling down purchases, while the ECB and BoJ will do more. Also, we expect controlled market conditions for German Bunds to become a blueprint for US rates. The People’s Bank of China (PBoC) has become more accommodative as well, and we expect a further reduction in rates to be part of their measured, targeted easing path.

With the strong reduction in rates over the past weeks, our scenarios for central bank easing are now fully priced in, except in China.

Outlook for central bank policy rates

Source: Bloomberg, Robeco, change 12m ahead, based on money market futures and forwards

Lower rates for a lot longer in the US

Since early March, the Fed has cut rates by 150bps, introduced at least a dozen support programs, bought USD 1.5trn in US Treasuries and MBS, opened FX swap lines, facilitated repos, eased leverage requirements and shown flexibility on credit rating criteria. In sum, the Fed has been forceful, flexible and creative in its response to the crisis.

The Fed will likely keep rates at zero for a long time. By ‘a long time’, we mean at least two years. Why? First, because they are not likely to meet their employment and inflation targets anytime soon. We think the consensus is still too optimistic on the trajectory of the bounce. Second, because Fed officials have repeatedly underlined their preference for forward guidance as a policy tool. And third, because low inflation expectations remain an important long-term concern. Being patient in raising rates should help in lifting these expectations.

Negative rates, however, are less likely. At his 15 March press conference, Fed chair Powell repeated that this is not their intention.

In Europe, an increase in PEPP is likely; the question is when

Although the measures announced at the early-March ECB meeting were significant, they were not considered sufficient in the eyes of European bond markets. President Lagarde’s remark that the ECB was not there to “close [bond] spreads” may not have helped in that regard. Hence, it took less than a week, during which spreads widened sharply, before the ECB was forced to step in and launch the new Pandemic Emergency Purchase Program (PEPP), with an overall envelope of EUR 750 billion. Simultaneously, it was decided to expand the range of eligible assets under the corporate sector purchase program (CSPP) to non-financial commercial paper.

The initial pace of PEPP purchases has been impressive and, probably due to the fact that purchases are conducted in a flexible manner skewed towards peripheral government debt, have managed to halt a further rise in European Government Bond spreads. Nevertheless, the pace still dwarfs that of the US Federal Reserve. Given the huge funding needs of Eurozone sovereigns – it seems likely that many countries will have budget deficits and hence net debt issuance of more than 10% of GDP in 2020 – it seems a matter of time before the PEPP envelope of EUR 750bn will be increased.

Politburo signals more monetary easing to come

A lot has happened since our previous update on the PBoC, in early March. As we had expected, the central bank has indeed stepped up the pace of monetary easing.

This seems in part driven by the worsened external demand outlook in the wake of the economic lockdowns in Europe and the US. But the policy loosening also seems related to incoming evidence on the sheer scale of the Covid-19 shock, with Chinese real GDP having contracted by an unprecedented 6.8% year-on-year in Q1. Even though the viral outbreak in China has seemingly moved (further) in the right direction and industrial activity is gradually getting back to a more normal pace, the 17 April Politburo meeting signaled that there is still more macroeconomic policy loosening to come.

Enhanced monetary easing in Japan

While initially reluctant to act in response to Covid-19, the BoJ finally enhanced their monetary easing bias forcefully – and we expect more to come. While the easing framework offers little surprise, we do take a positive view of the qualitative and quantitative easing designed to ensure smooth financing of financial institutions and corporates, amid the sharp economic downturn triggered by the Covid-19 crisis. For the Japanese economy, the timing of this shock could hardly be worse, as the economy was still struggling with the negative effects of the VAT hike at the end of last year.

With the BoJ now more actively supporting the government by additional buying of Japanese government bonds, and through more pronounced support of the private sector at the request of the government, we could be witnessing the first steps of monetary policy being made explicitly accommodative of fiscal policy – in other words, fiscal dominance.

Download the Central Bank Watcher
With our latest analysis of global monetary policy.
Download
Logo

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree