We write a lot about monetary policy on this site, not because we enjoy the parlor game of trying to predict what the world’s central bankers are going to do next, but because over recent years, monetary policy has become the king-maker in financial markets. Those ignoring the actions, reactions, and mostly overreactions of the global central banking cabal may be unwittingly taking risks that have emerged as a result of the unprecedented scale of central bank intervention.
First it was zero rates, then it was quantitative easing, then it was zero rates for longer. When these unconventional policies failed to ignite the kind of growth and inflation that the Keynesians who run the world’s monetary policy had hoped for, it was on to even more unconventional policies. Negative rates are now a part of the monetary tool kit and helicopter money or the outright printing money has been floated, but not yet tried.
The latest policy to come out of the monetary policy test kitchen is the buying of corporate bonds by the European Central Bank (ECB). The ECB’s corporate bond buying program was announced earlier this year, but it wasn’t started until this week. The ECB is printing money and buying corporate bonds of non-financial companies in the euro-area.
The Wall Street Journal reported on some of the details of the program.
Many analysts and investors also are uncomfortable with the idea of a central bank making decisions about which private companies get funds. Such criticism has been particularly strong in Europe’s largest economy, Germany, where a range of critics have attacked the ECB’s stimulus measures.
Deutsche Bank’s chief economist, David Folkerts-Landau, on Wednesday called the decision to buy corporate bonds “an act of desperation.”
“The central bank is trying to play the role of commercial bank by lending to the corporate sector,” and that will lead to misallocation of funds and sap business confidence in policy makers, he said.
The ECB hasn’t said how much corporate debt it will buy, but most analysts expect it to target between €5 billion and €10 billion ($5.7 billion and $11.4 billion) a month, in a market estimated at roughly €600 billion. The central bank will buy investment-grade bonds of companies established in the euro area, but not banks. It will buy up to 70% of each bond issue.
The economic, political, and investment implications of a central bank printing money to purchase the debt of private corporations is rather disturbing. You have questions of unfair subsidization, misallocation, mispricing, and of course manipulation.
It was bad enough when central banks were distorting government bond rates by hoovering up most of the available supplies. Now the ECB is printing money to buy up to 20% of all outstanding non-financial euro-area corporate bonds over the course of a single year and up to 70% of single issues. There’s no way the rates on euro-area corporates can reflect anything close to the true market rate when the biggest buyer of bonds is an actor with an unlimited supply of funds and no motive to earn a profit or minimize risk.
The distortion of risk isn’t anything new. Central banks have been distorting risk across the global investment landscape for years now. But the ECB’s recent move to intervene in the corporate credit market has taken this to a whole new level. And it isn’t just Europe that’s impacted. Capital flows freely across borders. Investors being driven out of euro-area government and corporate bonds by the ECB’s no-holds-barred approach to monetary policy are most definitely finding their way into U.S. bonds.
What happens when (ok maybe if) the ECB decides it has met its policy objectives and ceases buying corporates, or maybe even decides to sell them? Look out below is a phrase that comes to mind. Stay alert to the risks that central bank intervention creates in markets and continue to manage your portfolio using a prudent approach.
Jeremy Jones, CFA
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