This week is one of the most important ever for central banks around the world – they just don’t realise it yet. Or maybe they do.
Last week’s move by the Swiss National Bank to scrap the Swiss franc’s peg to the euro has led to a sharp appreciation of the Swiss currency but, more importantly, it has started a chain of reactions that could well spell the end of central bankers’ unlimited power to influence markets.
In concrete terms, the Swiss announcement has put some foreign exchange brokers out of business and has weakened banks in Central and Eastern Europe further, because of the danger posed by loans extended in Swiss francs in the boom years.
But more importantly, it has shaken investors’ trust in central banks’ ability to steer market expectations.
In a presentation in London last week before the Swiss National Bank’s announcement, Marc Faber warned that this could be the year when central banks lose their credibility.
“The idea that you can create growth with bubbles – what kind of stupidity is that?” the author of the Gloom, Boom and Doom Report said at a conference organised by Societe Generale.
Central banks “only hire people who think money-printing is good,” and this has led to policies that have inflated asset prices without benefiting the real economy, he said.
Swiss interest rates were pushed deeper in negative territory, while the ECB also has a negative interest rate.
But, Faber warned, the lower the interest rates go the more spooked investors could become. Low interest rates “may lead some people to say they are worried, and to save even more,” he said.
“The worry is that the central banks can pump money into the system, but that will not help.”
‘Nowhere to hide’
At the same meeting – dubbed a “bear fest” – Andrew Lapthorne, head of global quantitative strategy at Societe Generale, said that the normalisation of interest rates meant that “lots of people who don’t like risk will lose money.”
This is because of the so-called financial repression that has taken place since the financial crisis and which has pushed money into riskier and riskier assets in search of elusive yield.
Lapthorne noted that the S&P 500 has not lost 10% or more for 800 days.
“This is relevant if you think stocks are expensive, like we do. As a buy-and-hold investor, you’re making the lowest yield possible. Within the equity market, there is nowhere to hide.”
Albert Edwards, the Societe Generale strategist dubbed an “uber bear” by the financial media, said that despite the signs of deflation that currently worry policymakers, “all this printing by central banks will end in tears, will end in inflation.”
“I think this is the year when markets panic about it. We haven’t seen that panic yet,” he warned.
The conference room was full and there were many nods of approval from the audience. Even if such sentiment is not yet prevalent in the markets, it is spreading. This is the big problem that central banks have to face.
So far, the European Central Bank (ECB) has managed to steer markets with soothing words about how quantitative easing will be unleashed, if really needed.
The trouble is, it looks like investors have already priced in full-blown, sovereign bond buying by the ECB.
ECB president Mario Draghi faces a big challenge at his first news conference of the year on January 22: not only must he announce a programme that exceeds the markets’ expectations to stay ahead of the curve — he must also restore the credibility of central banks, badly damaged by the Swiss central bank.
If anyone can do this, it’s “Supermario.” Investors should watch the January 22 news conference carefully — it could turn out to be the most important central bank communication of the year.