Caught Between “Conventional” and Forced “Unconventional” Policy-making Manuel Balmaseda CX Economics
Eighth Annual Rocky Mountain Economic Summit Jackson Hole, July 2016
Tapering: costless strategy? A difficult Fed exit, nothing new Monetary policy normalization will have costs regardless the way it is implemented Oct. 13
1) Disorderly exit
2) Too late/too soon exit
Long term inflation expectations disanchoring
Permanent vs. transitory effect of financial crisis on potential growth • Sunk costs: Fixed income bubble? Any other bubbles?
3) Right in time exit
• Coordinated or uncoordinated (first mover disadvantage) • Inefficient allocation of resources • Impact on EMs -2-
19
Central Banks: from “lenders of last resort” to “buyers of first resort” Central banks’ balance sheets Billions USD, EUR 5.0 4.5 4.0 3.5 3.0
(assets) Trillions JPY 500
FED
BOJ
20%
450 400
64%
(right axis)
1.5
350 300 250
2.5
17%
2.0
ECB
• Unusually dominant role of central banks in financial markets in recent years
200 150
1.0
100
0.5
50
0.0
0
• Potential build-up of financial imbalances in the form of excessive risk-taking and growing indebtedness since the crisis • Possible overvaluation of assets • Risk of unleashing a chain reaction of financial instability?
Source: FED, ECB and BoJ
Unwinding of extraordinary lax policies may be complex and risky in terms of price and financial stability Fed: FIFO -3-
Central Banks: At different stages of monetary easing Short-term rates (%) 0.6
• US, when will it raise rates again?
Fed Funds 0.4
• Euro Area and Japan, will they ease further?
0.2
• Divergent monetary policies in a highly economically and financially integrated world?
0 -0.2
• Volatility of capital flows and uncertainty about the implications for exchange and interest rates
3m Euribor
-0.4
Feb-18
Nov-17
Aug-17
May-17
Feb-17
Nov-16
Aug-16
May-16
Feb-16
Nov-15
Aug-15
May-15
Feb-15
Nov-14
Aug-14
May-14
Feb-14
Nov-13
Aug-13
-0.6
Source: Bloomberg
Volatility and uncertainty resulting from monetary policy divergence could further accentuate the perception of risk Federal Reserve, more reluctant in this environment to “normalize” monetary conditions -4-
Is the sky the limit? Monetary policy as a XXI century economic snake-oil Stock of government bonds with negative yields Rest of the world 7.5
Japan Euro area
Trillion USD
• Too many unknowns in the equation: • Limits of monetary policy close to the zero lower bound • Declining trend in real interest rates, structural or cyclical?
5.0
• Negative rates. Will benefits outweigh costs? Unchartered waters (banking system, money market-funds, insurance companies, savers in general)
2.5
• Why not go farther into unchartered territory? Long-term interest rate targeting and/or fiscal deficit monetary financing
0.0
Source: BIS
Returns to expansionary policies seem to be decreasing. Loss of credibility? -5-
Fed is what matters for EMs Ratio of total foreign currency debt to GDP (USD billion) 45
Other currencies
40
EUR USD
35
• Divergence hardly provide some breathing space for EMs (dominance of the US dollar in international financial markets) • Impact of US shocks in EMs is much larger than other shocks
30 25
• Indirect effects of divergence:
20
• Fed may delay normalization
15
• Big countries, as China, moving away from US peg (significant impact on financial markets)
10 5 0
Latin America
Asia
Other EMEs
China
Source: BIS
Expectations of Fed policy is what drives EMs, but those expectations are affected by other Central Banks’ actions -6-
Fed policy and channels of transmission to EMs Impact of Fed tightening • Trade effect (+)
1. Exchange rate channel
USD appreciation vs EMs currencies
• Balance-sheet effect (-) • Risk of pass-through?
2. Effect on international financial conditions
3. US domestic demand channel
• Impact on capital flows, term premia, asset valuations • Usually associated with higher market volatility and risk aversion
• A concern particularly for countries with large financing needs and/or imbalances
Rate hikes justified by a underlying strength of US economy => mitigate negative impacts
External factors also play a role (China) -7-
How much farther can the Dollar go? 1. Exchange rate channel Exchange rate vs USD since Aug-2015 51%
ARG MEX EGY UK RUS CHN MY TUR IND COL POL PER ISR DOM PHL BRA THA CR HUN SWI IDN EURO CZE CRO JAP
-20% Depreciation vs the USD Source: Datastream
The Mexican peso has been the worst performing currency among the flexible exchange rates
0%
20% Appreciation vs the USD -8-
Balance-sheet effect: too much corporate debt in foreign currency ? 1. Exchange rate channel Corporate debt %
• Contrary to other crisis, no signs of severe currency mismatches in the banking sector and/or government borrowing (lessons from other crisis)
(% of GDP)
Mexico Indonesia S. Africa
In USD
India
Rest
• The main pressure point could be offshore foreign-currency borrowing by emerging market corporations
Brazil Turkey Russia Malaysia Korea China 0
50
100
150
200
Source: BIS
Difficult to see how large is the risk associated to corporate debt - 10 -
Risk of pass-through to inflation reduces the autonomy of monetary policy 1. Exchange rate channel Inflation and CB´s target range 12
Average inflation (last 3months)
• Exchange rate pass-through heightens the inflationary risk
Central bank´s target range
10
• Traditional dilemma: above target inflation and slow growth
8 6
• The magnitude of the pass-through in several countries suggests that output gap was less negative than previously thought
4 2 0
PER
Source: National Central Banks
BRA
CHL
MEX
COL
• In Mexico, no sign of pass-through despite the large depreciation. Positive impact of structural reforms in prices (telecom, electricity, gasoline).
Pass-through to inflation? Yes in some. Not in others, but be aware - 11 -
Higher exposure of those countries with higher financing needs 2. International financial conditions Current account balance (% of GDP)
10
• In some countries (Brazil, Chile) the current account adjustment is quite advanced (imports contraction)
8 6 4
• In others (such Colombia) it is clearly a source of risk
2 0
• In Mexico, no room for comfort (downward pressure from oil balance will continue – production weakness – and fiscal adjustment is proceeding too slowly -)
-2 -4 -6
KOR
RUS
MLY
CHI
IND
CHL
IDN
MEX
BRA
SAF
TRK
PER
COL
-8
Source: IMF
EMs central banks could be required to become “unconventional” - 14 -
How can EMs central banks deal with this situation? Pseudo-independent Central Banks • EMs should:
Mexico: International Reserves
• monitor closely their monetary policy stance relative to advanced economies, to minimize the potential of capital outflows
(Billion USD) 300
IMF’s Flexible Credit Line
250
• strengthened macroeconomic fundamentals and structural reforms to compensate the decompresion of term premia
200
150
International Reserves
100
• Global safety nets are insufficient to deal with massive capital outflows (work to be done on this).
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
0
2006
50
• Large FX reserves accumulation by Ems (complemented, in some countries, with the IMF´s FCL).
Source: Banco de Mexico
Reserves cannot be the ultimate solution, but they can buy time Monetary policy in EMs conditioned by Fed policy - 15 -
How about Banxico? 17-12-15
+25bp following the FED hike
Anticipated
17-02-16
Discretionary intervention in FX markets End of regular USD auctions +50 bp
Non anticipated Not scheduled meeting
30-06-16
+50 bp
Non anticipated
• Part of a “Coordinated” response to “strengthen fundamentals” • Volatility in MXN accentuated by automated mechanisms for high-frequency trading • Banxico becomes unconventional
1. Despite “apparently” sound economic fundamentals, the Mexican peso has been the worst performing currency this year • No significant impact of FX depreciation on exports (integrated value chains, weak US demand) • Non-negligible share of corporate-debt in USD • No pass-through to inflation, yet (producer prices are increasing)
2. Vulnerability of Mexico to financial distress episodes • Very open and highly integrated financial market (use as proxy to emerging market) • Large share of government bonds in hands of non-residents (%) • Fiscal consolidation still ongoing - 16 -
Caught Between Forced “Unconventional” and “Conventional” Policy-making Manuel Balmaseda CX Economics
Eighth Annual Rocky Mountain Economic Summit Jackson Hole, July 2016