Cash binge to end

For bingers who claim that they’re not ready to leave the party yet, central bankers are jiving hard to convince us that they know where the exits are. My bet is that they’ll bail sooner than financial markets think.

But hey, what a swell party this is! Official interest rates at or near record lows almost everywhere; bond yields signalling a benign inflation outlook; equity markets roaring ahead; emerging markets on fire; and commodity prices pointing to a V-shaped recovery that seemed impossible as the year started. Cheers!

The better the shindig, the harder it is to know when to leave. Depart too soon, and you might miss out on a whole heap of fun.

Dance until dawn is peeping through the curtains, and the hangover could be crippling.

Central bankers, though, are starting to shuffle nearer the door, signalling to each other that it might be time to retire gracefully before tables get danced on, clothing discarded, and reputations trashed.

“We will need to remove our very accommodative policy sooner rather than later,” Federal Reserve Bank of Kansas City president Thomas Hoenig said in a speech last week. Fed governor Kevin Warsh said last month the US central bank may need to raise interest rates “before it is obvious that it is necessary, possibly with greater force than is customary”.

The last time central bankers got financial markets inebriated on free money, the aftershock was akin to the next- day trauma suffered by a teenager who thought imbibing a stolen bottle of cherry brandy would be a fun way to spend an evening.

The Fed must have learned its lesson about keeping borrowing costs too low for too long. Mustn’t it?

Australia has already skipped the revels. This week, it became the first among the Group of 20 nations to drive up borrowing costs since the collapse of Lehman Brothers in September 2008 exacerbated the crisis. The central bank announced a surprise quarter-point boost in its overnight cash-rate target to 3.25 percent.

Significantly, the Reserve Bank of Australia did so even while the country’s unemployment rate is stuck at a six-year high of 5.8 percent — a lesson for anyone who thinks joblessness will guarantee the status quo. Other central banks might be similarly inclined.

“I don’t think that is a showstopper if the unemployment rate hasn’t starting falling yet,” Fed Bank of Richmond president Jeffrey Lacker said this month. Even though the Fed hasn’t previously boosted borrowing costs while workers were still losing jobs, “there is a first time for everything”.

The futures market is convinced that interest rates are going nowhere fast. The three-month dollar contract for settlement in December 2010 shows a rate of about 1.6 percent; while that’s way more than the current 0.3 percent cost of borrowing the US currency for 90 days, the futures rate has been ticking down on almost a daily basis for two months, and is down almost a full point since the first week of August.

There’s a similar picture in other markets. The December 2010 euro contract, for example, has tumbled to about 1.8 percent from 2.6 percent three months ago; the British pound version is down to 2.15 percent from 3.47 percent on June 11. Traders are scaling back their rate expectations even as the equity market suggests the global economy is mending.

That could be a mistake. Central banks will find it hard to keep beating up on investment bankers for the sins of the financial industry without policy makers also showing that they have examined their consciences and found room for remorse. A swifter than predicted return to a more normal monetary-policy environment would be one way of proving that the lessons of the bubble years have been learned.

With liquidity seeming to improve, the temptation for central bankers to water down the punchbowl, if not remove it completely, will increase. The one financial bet that does seem misguided for the next year or so is to anticipate that there will be no change in policies, no removal of stimulus, and a smooth glide back to the good old days.

So, don’t be fooled by the clinking glasses in the stock market and the soothing beats in bonds. The music could come to a sudden halt if the central banks, who have been the life and soul of the recovery party, all rush for the exits at once.

Mark Gilbert is the London bureau chief and a columnist for Bloomberg News. The opinions expressed are his own.

Print | Email | Discuss this article

| Share |

READERS' COMMENTS

Click here to post a comment

Add your Comment All posts are sent to the administrator for review and are published only after approval. ArabianBusiness.com reserves the right to remove any comment at any time for any reason. Please keep your responses appropriate and on topic. Arabian Business would like to point out that only comments relevant to the story will be published. Any containing personal insults or inappropriate language will not be approved.
Name *
Remember me on this computer
Email *	(Your email address will not be published)
City
Country
Subject *
Comment *
Notify me of further comments
Enter the words above *
Please click post only once - your comment will not be published immediately.

MORE FROM ARABIANBUSINESS.COM