With baby steps, the Fed and other major central banks are beginning their journey back towards some semblance of normality.
This will be a big resilience test for a financial system which, for more than a decade, has relied on repeated rounds of monetary generosity.
As central banks need to be seen as leading the markets, not following them, lessening their monetary policy largesse seems to come at the right time.
In the so-called “real” economy, sentiment is improving. A recent poll by think tank Oxford Economics showed that a majority of businesses have turned more positive about the global economy in the past month.
The companies usually taking part in Oxford Economics’ surveys employ around six million people overall, and have a collective turnover of around $2.0 trillion. Around 175 businesses filled in this month’s survey, which ran between March 3 and March 11.
Almost half the respondents (49%) said they had become slightly more positive about the prospects of global growth for the next two years, while 18% said they had become significantly more positive.
When it comes to the recovery of their own business to levels before the Covid-19 pandemic, a majority of respondents said it would most likely happen in the second half of this year.
Around 12% said it could happen in the first half of this year, while 11% said the third quarter and 9% the fourth quarter.
Another survey shows optimism, even bullishness, in the financial markets as well. For the first time since February last year, Covid-19 is no longer ranked as the biggest risk by fund managers in Bank of America’s monthly survey.
Inflation and taper tantrums are now considered bigger risks — which explains the central banks’ policy shift.
Fed walking on eggshells
The Bank of Japan introduced a nuance in its asset purchases policy that could turn out to be the beginning of tighter monetary conditions: instead of steadily buying exchange-traded funds (ETFs), it said it would purchase them “as necessary”, with an upper limit of 12 trillion yen ($110.2 billion).
This is still a lot, of course. But purchasing “as necessary” is not the same as regularly dipping into the market. The Bank of Japan, while still holding investors by the hand in navigating market volatility, has loosened its grip ever so slightly.
The Federal Reserve seems to be sending a clearer message to investors: It will not extend the exemption on capital rules for banks that were buying Treasury bonds, allowing it to expire at the end of March.
The markets have been testing the Fed’s resolve on this issue for a while, and it looks like the Fed is calling their bluff.
But even on this tiny change in policy stance, the Fed is stepping on eggshells. In a statement last week, it reiterated that it temporarily modified the supplementary leverage ratio (SLR) in April 2020 to exclude Treasury securities in order to promote lending at the height at the pandemic.
And while it acknowledged that the Treasury market has stabilised since then, the Fed still said: “because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the Board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability.”
The statement shows that the world’s strongest central bank is still wary of doing anything that would spook the markets even further, leaving the door open for a reversal of the policy if need be.
With the 10-year Treasury yield jumping 0.38 percentage points to 1.726% in the course of a month, few could deny that is a wise decision from the Fed.