Fisher Investments Editorial Staff
Monetary Policy, Into Perspective, Interest Rates

Cloudy, With a Chance of Rate Cuts?

By, 02/04/2015
Ratings164.15625

What do Australia, Singapore, Russia, Canada, India, Denmark and Switzerland have in common? Well, yes, they are all countries.[i] But also, their central banks kicked off 2015 with monetary policy shifts—most were moves analysts didn’t foresee. A cautionary tale! But one many don’t seem to heed, as they seem doggedly determined in their attempts to predict future monetary moves. In our view, this misses the real lesson: It is impossible to game how central bankers will act. For investors, we suggest opting out of this exercise in futility.  

First, consider: Which monetary policy shifts were telegraphed? The Central Bank of Russia (CBR) abruptly cut its key interest rate by two percentage points last Friday. This comes only about a month after mid-December’s “shock-and-awe” rate hike from 10.5% to 17% to stem the ruble’s decline. Which itself came days after another rate hike. Those two moves had analysts projecting hikes through 2015. Despite the lack of a “smoking gun,” Australia surprised by lowering its interest rate Tuesday for the first time in 18 months to a record-low 2.25%. And several days after one Swiss National Bank (SNB) official said that its franc/euro exchange-rate floor was a “pillar” of the bank’s monetary policy, the SNB deleted it on January 15. Pundits were shocked, calling it “a complete surprise;” “the biggest currency shocker in years;” “a tsunami.” These aren’t the only examples, either. The Monetary Authority of Singapore announced it would ease monetary policy and target a slower appreciation of its dollar.[ii] The Reserve Bank of India and the Bank of Canada cut rates. The Danish Nationalbanken lowered its key rate 25 basis points[iii]the fourth cut in three weeks—to -0.75%. Days ago, analysts prognosticated China wouldn’t make any moves like cutting the require reserve ratio (RRR) until after the Lunar New Year is over (so, March-ish). They cut it Wednesday. Now, many analysts did anticipate the ECB announcing January’s quantitative easing (QE) program, but precious few industry experts foresaw any of these other moves. (And the common analysis of the impact of ECB QE seems off, to us.) Our aim here isn’t to point out missed calls—rather, this shows just how difficult, if not impossible, it is to reliably predict central bankers’ actions. 

Yet that hasn’t stopped those same industry experts from attempting to predict what other central banks will do next. Some equate Denmark’s situation with Switzerland’s and wonder if the Nationalbanken will eventually drop its euro/krone currency peg like the SNB did, threatening more currency traders and clearing houses in the process. Given Denmark boosted its foreign exchange reserves by 106.6 billion krone ($16.4 billion) in January and the Nationalbanken said it would produce “an unlimited supply of Danish kroner” to defend its peg, it seems like the Danes are preparing so they don’t become “another casualty” in an alleged “currency war.”[iv]

However, there are some key differences. For one, the SNB’s peg was known to be temporary, while the Nationalbanken’s is over 30 years old.[v] Denmark’s currency peg also enjoys ECB backing—the central bank is obligated to intervene to support the exchange rate if necessary. (Which also means Denmark doesn’t have fully independent monetary policy.) And the Nationalbanken’s balance sheet is presently about 15% of GDP, while Switzerland’s swelled to roughly 90% defending its peg. We aren’t saying Denmark’s peg will last forever and always—currency pegs are inherently unstable. But predicting a Danish move based on the Swiss peg breaking is a stretch. The facts on the ground matter. And speaking of Switzerland, some are still trying to divine their next move! Some now speculate the SNB will informally install a new floor of 1.05-1.10 CHF per euro. Even if that’s true, acting on the assumption would literally be repeating the same error some currency speculators made only weeks ago. Analysts are now projecting a slew of additional Chinese moves this year, despite the latest one blindsiding most.

In the US, the president of the Cleveland Federal Reserve said the Fed should raise rates by June because of the economy’s increasing growth momentum, while others disagree. However, opinions from central bankers who don’t have FOMC votes this year don’t seem terribly telling to us—these are all words about words, words, words. While fine for headline fodder, for investors, taking what central bankers say (or the analysis about what they say) literally can be a problem.

Central banker language is marketing spin. Fed transcripts from September 2008 confirmed as much as Ben Bernanke’s Fed debated adding the word “closely” to its policy statement and how the general public would interpret it. Central banker “forward guidance” is just another variety of this spin—it isn’t a promise to do anything. Though most central banks claim their monetary policy is data-driven, those decisions are subject to how central bankers interpret the data—and those interpretations can change. BoE governor Mark Carney has been called an “unreliable boyfriend” due to his constant flip-floppery about a future rate hike. At first, it depended on unemployment numbers. Once unemployment came around faster than anticipated, Carney found other ways to dillydally. And consider again the SNB’s abrupt flip-flop: Three days after stressing the euro/franc peg’s importance for Swiss exports and the economy, it was toast. Now there are some places where monetary policy isn’t necessarily “data-dependent”—see Russia, which just cut rates due to political pressures. However, we would humbly suggest “President” Vladimir Putin’s actions are equally impossible to forecast.

For investors, we suggest tuning this noise out—acting on vague words, rather than concrete actions, isn’t a good portfolio move.

 

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[i] And Singapore is a city-state.

[ii] Singapore doesn’t target overnight rates as its primary monetary policy tool, it uses the Singapore dollar’s value. This is the Singapore version of a rate cut.

[iii] A basis point is one one-hundredth of a percentage point, so a 25 basis point cut is -0.25 percentage points.

[iv] A currency war is a “competitive devaluation,” in lay-person speak, an attempt to weaken your currency against another to make your nation’s exports cheaper. This assumes weak currencies really goose exports (overstated), that exports are 100% domestic content (rare, in this globalized world) and that you can intuit not only bankers’ net move, but their motives. We aren’t convinced a currency war is a thing.

[v] The euro is obviously not 30 years old—before it was born, Denmark pegged the krone to the deutschemark.

 

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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