Wednesday, April 6, 2011

Review of Global Central Bank Policy

In this morning’s daily report, Ed Yardeni provided a useful review of Central Bank policy around the world. Since one of the biggest risks to the current bull market is a reversal of policy from being accommodative to being restrictive, I thought it was worthwhile to share some of the information in Yardeni’s report.

The big news in the U.S. is the presumed end of the Fed’s Quantitative Easing (QE2) policy this June. The Fed has been buying securities through their permanent open market operations (POMOs). This money has been finding its way into risk assets, especially the stock market. Investors are worried about what happens when the Fed stops buying. In the meantime, the Fed Funds rate remains at zero and the expectations are that it will remain there “for an extended period.”

The European Central Bank is pursuing a different course. They are expected to raise their lending rate from 1% to 1 ¼%, and investors seem to be anticipating an additional ½% to ¾% raise before year-end. The EU is struggling to “normalize” interest rates even though higher rates will penalize the PIIGS (Portugal, Ireland, Italy, Greece, Spain) by driving the euro higher which is a headwind to growth. The euro has already risen from 1.29 in January to 1.43 this morning.

The Bank of England is on hold at 0.5% and recent economic data is not encouraging.

The Bank of Japan has injected huge amounts of liquidity into the banking system since the natural disasters last month. Their bank reserve balance jumped 53% from 15.9 trillion yen to 24.4 trillion yen.

The People’s Bank of China yesterday raised interest rates to 6.31%. The have raised their bank reserve rate six times since last October, all in attempt to slow inflation that is expected to be 5.1% year over year when it is reported on April 15th. Like other emerging markets, China is struggling with food and energy inflation problems.

Brazil’s central bankers yesterday proclaimed that they will fight inflation next year. While their target inflation rate is 4.5% current inflation is running 6.13% YOY.

The bottom line is that investors who are worried about central banks “normalizing” or raising rates to historically normal levels probably have good reason to worry. Yardeni thinks that the bull market is being driven by higher corporate earnings and that the market will adjust to higher rates and the bull market will continue. However, even he is again warning about the risks of a correction.