March 2016 Recap

March is usually a month of change. Winter’s cold gives way to the first hints of spring, and we make the rounds in our homes changing the time on the clocks and our watches by one hour as we “spring forward” in observance of Daylight Savings Time. However, the one thing in March that never seems to change, at least not for a lot of us, is how we fair in the “March Madness” office pool. The NCAA Men’s Division I Basketball Championship is often referred to as “the Big Dance”. For a lot of us though, it might as well be called “the fat chance” because we’re out of the running to win some money every year.  Like Caesar, many of us could have used a Soothsayer at the office bidding us to “beware the ides of March.” Maybe we would have taken his warning as a hint to toss our tournament brackets in the trash and keep the entry fees in our pockets. Since we’ve all been told that misery loves company, we can take some comfort from learning that we’re not alone in our bracket-filling futility this year. According to Yahoo Sports, not one of the brackets submitted to their site - and there were millions of them – had a clean sheet after the first round of 32 games. That’s never happened before. March Madness, indeed.

March Madness extended to more than the confines of college basketball in March. It would be hard to label what several of the world’s central banks did during the month anything other than more “March Madness.” The world’s central bankers even have their own version of the Final Four: 1) our Fed, the Federal Open Markets Committee (FOMC), 2) the European Central Bank (ECB), 3) the Bank of Japan (BOJ), and 4) the Peoples Bank of China (PBOC). In March, all four of these banks either deployed new accommodative measures in an effort to stimulate their economies or reiterated their position to leave extraordinary stimulative measures in place. Each bank, and the countries they represent, continue to struggle with how to deal with anemic global growth. Their accommodative actions in March propelled risk assets like stocks and real estate to new highs for 2016, but also increased the likelihood and maybe the impact of unintended consequences in the future.

Central Bank Actions

The ECB pulled out the “big bazooka” in March when it unveiled a series of extraordinary policy moves to help spur economic growth and support asset prices in the Eurozone. The central bank reduced benchmark interest rates further, expanded its securities purchase program from €60 billion to €80 billion a month, and broadened the scope of its quantitative easing (QE) effort to include non-financial corporate bonds. The deposit rate was moved from -0.30% to -0.40%. Note that those are negative interest rates. Depositors that already had to pay the banks to hold their money will now have to pay them even more.

Just a few days after the ECB’s stimulus bombshell stunned the markets, China’s central bank announced that it would keep its accommodative measures in place for now and would keep a flexible stance in the event of an economic shock - domestic or global. This “wait and see” decision from the PBOC wasn’t unexpected as the bank lowered reserve requirement ratios in February and cut interest rates six times since November 2014.

The BOJ didn’t unveil any new stimulus measures in March, but it left in place extraordinary measures that it put to work only a few weeks earlier. It was then that the BOJ blindsided the global markets by unexpectedly announcing that it would, like the ECB, apply a negative rate to some excess reserves that financial institutions place at the bank. At the March meeting, the BOJ reiterated its commitment to raise the monetary base by 80 trillion yen annually and left the rate it charges commercial banks on certain reserves at 0.1 percent. Not surprising to many, the BOJ is experiencing a significant backlash of anger and frustration from the public, especially older citizens on fixed incomes, in response to negative interest rate policies. There have been numerous reports of senior citizens buying safes to hoard cash amid fears that commercial banks may soon charge them interest on their deposits as well.

In the U.S.

Fed Chair Janet Yellen’s statements following a late March Fed meeting had a clearly dovish tone. Yellen advised caution and said that global and financial uncertainties posed risks to the U.S. economy and justified a slower path for rate increases than previously planned. She announced that the Fed would leave official rates unchanged, which was expected, but her statement that the Fed had reduced the number of expected official rate hikes for 2016 from four to two raised the eyebrows of most economists that track Fed activity.

The Fed acknowledged that it is even considering negative interest rates as a potential policy tool, but at this point, that tool would only be part of a contingency plan. There is some question as to whether the Fed has statutory authority to cut rates below zero, but that issue is expected to be resolved soon. In any case, the Fed will observe how negative policy rates play out for other countries before deciding whether to use such an approach for future easing initiatives.

So here we are. Since 2008, we’ve gone from quantitative easing (QE) and “extraordinarily accommodative”, near zero percent interest rate policies (ZIRP), to expanding QE, and now to exploring negative interest rate policies (NIRP). Central bank policymakers are also considering an even more extraordinary stimulative tool if the ones now in place don’t bear fruit. The tool is known as “monetary finance”, but it’s also been called “helicopter money” because the plan is basically to print money and then give it to the public to spend on goods and services. A prominent central banker once likened it to taking a helicopter full of money out over the city and then throwing money out to the masses. The goal is to drive up consumption and thereby stimulate the economy. The whole plan may sound crazy, but don’t be surprised to see it put into action somewhere in the world soon.

So why have central banks in Europe and Japan resorted to negative interest rates? They are desperate to stimulate consumer demand in their countries and stoke worryingly low inflation. In China, the growth target set by the government of at least 6.5% in 2016 seems like a great thing to even shoot for compared to the rest of the world’s economies, but it’s the slowest pace of economic growth in China in 25 years. Here in the U.S., our massive monetary stimulus policies put into action over the past several years may seem pedestrian compared to what central banks elsewhere have deployed, but policy makers here expected growth earlier and greater than what we’re seeing now.

Asset Prices

As expected, further ultra-accommodative policy actions by the world’s central banks have greatly influenced global asset prices so far this year. Artificially low interest rates continue to push investors out of cash and bonds and into riskier assets, like stocks and real estate. Year-to-date, the S&P 500 has bounced back from its mid-February low and is now just above breakeven for the year, advancing more than 6% in March alone. In fact, the Dow Jones Industrial Average, another U.S. stock market gauge, just posted its biggest quarterly comeback since 1933 during the first quarter of 2016.  World markets also rallied strongly after tumbling during the quarter and now also sit just above break even for the year.

Currencies

Central bank policies have greatly impacted currencies as well. Normally, when a country cuts its interest rates or prints more money, the currency drops in value and that country’s goods are cheaper, meaning its exports usually benefit. However, the recent “race to the bottom” in interest rate policy by the world’s central banks has actually caused some of those country’s currencies to rise in value. The currencies that have appreciated the most year-to-date are interestingly those of the countries who have taken their rates into negative territory, which is worrisome for their central banks. One could conclude from this that currency markets are no longer responding to policy. But a better explanation is probably that we are seeing an unwinding of consensus trades that are overwhelming the impact of policy (such as bets on a rallying US dollar, and on outperformance of developed versus emerging markets).

Speaking of the USD, despite a rise of 11% against a broad basket of currencies last year, the dollar has fallen 2% so far this year versus the same basket. The largest factor in the dollar’s moderation is likely the lowered expectations across the market for the Fed to continue hiking rates. The prospect of higher rates led many investors to seek out U.S. assets before the Fed began to hike; volatility in markets and worries about the strength of the U.S. economy led many investors to ratchet down their expectations of rate hikes.

“Method in madness,” or madness in method?

It’s obvious that much of what’s driving the world’s capital markets is not investment fundamentals. Policymakers stepped in to “save the global economy” during the Financial Crisis, and they continue, in large part, to be the ones calling the shots. It may be madness that the future of the global economy is in the hands of a few dozen bureaucratic policymakers, but that’s the world that we live in.  But this doesn’t necessarily mean that the world’s capital markets are a poor place to invest. It just means that investors need to know the rules of the game, who the players are, and have a plan of action for what to do if and when capital markets start to take a turn for the worst.