Info Service on Finance and Development (Mar15/01)
27 March 2015
Third World Network
wave of monetary easing takes centre stage
Published in SUNS #7987 dated 23 March 2015
Geneva, 20 Mar (Kanaga Raja) -- A largely unexpected wave of monetary
policy easing over the past few months has taken centre stage in global
financial markets, the Bank for International Settlements (BIS) has
In its latest Quarterly Review of March 2015, the Basel-based BIS,
generally known as the central bank for the world's central banks,
said that amid plunging oil prices and rising foreign exchange tensions,
a large number of central banks from both advanced and emerging market
economies have provided further stimulus.
"The period of unusually low market volatility seemed to be coming
to an end as volatility in most asset classes reverted closer to its
historical averages. This was most pronounced in commodity markets,
where it spiked in early February, driven by a sharp fall in oil prices,"
Volatility also moved higher in foreign exchange markets, as looser
monetary policies started to spill over into increasing pressures
on managed exchange rates.
"In a surprise move, the Swiss National Bank abandoned its cap
on the Swiss franc/euro rate, while several other central banks adjusted
policies in defence of their exchange rate or inflation targets. The
US dollar continued to appreciate against the backdrop of diverging
monetary policies and sagging commodity prices."
BIS further said that actual and anticipated further central bank
monetary easing engendered unprecedented bond market conditions, even
compared with just a couple of months ago.
"A significant and growing share of sovereign debt traded at
negative yields, and even the yields on a few highly rated corporate
debt issues dropped below zero. Extraordinarily low interest rates
and compressed risk premia once again pushed investors into riskier
assets in their search for yield, sending prices of most asset classes
towards record highs in early March."
In recent months, said the report, volatilities broke away from the
exceptional lows recorded in mid-2014 and moved more in line with
their long-term historical averages.
Changes in market sentiment, driven mainly by lower oil prices and
developments in Russia and Greece, were reflected in higher implied
(forward-looking) volatilities of major asset classes. Commodity market
volatility was affected the most, with oil prices moving up to 9%
on certain days.
Stock markets were also more volatile than during September-November
2014. Exchange rate volatility edged considerably higher, partly due
to diverging monetary policies, and spiked after the Swiss National
Bank (SNB) decided to abandon its cap on the Swiss franc/euro exchange
Despite more pronounced spells of volatility, most asset prices reached
or moved close to new record highs. After sharp corrections in December
and early January, global equities rallied on the back of looser monetary
policies in both advanced and emerging market economies. Government
bond yields continued to decline, in many instances to new lows.
According to BIS, the drop in oil prices had driven up credit spreads
of US firms in particular, but spreads started to retract when oil
prices recovered from early February onwards.
Large oil price fluctuations drove the surge in commodity volatility.
The price of Brent declined from $71 per barrel at the beginning of
December to $45 in mid-January, but then recovered and stabilised
at $60 in mid- February. Increasing supply and, in particular, the
shifts in the production objectives of major oil-exporting countries
played a key role.
The prices of industrial metals and agricultural commodities also
declined, but by far less than that of oil, casting doubt on the importance
of demand factors as drivers of the fall in oil prices. The price
of copper, usually a strong indicator of global activity, fell by
10% during the period under review.
Lower oil prices severely affected the profitability and outlook of
energy-related firms. As a result, energy firms' stock prices fell
sharply and borrowing costs surged, before stabilising and partly
reverting, respectively, when oil prices bounced back in February.
"High debt burdens may force these firms to maintain production
despite the fall in prices in order to generate the cash flow necessary
to service the debt, thereby putting additional downward pressure
on the price of oil," said BIS.
The commodity price drop also drove down the exchange rates of net
commodity exporters. The central banks of Norway and Canada responded
to the risk of an economic slowdown by lowering interest rates, adding
further downward pressures on exchange rates. The Reserve Bank of
Australia cut its key policy rate by 25 basis points to 2.25% in early
February, citing concerns over weak domestic demand.
The central bank of Brazil, where net exports of commodities account
for 36% of the total exports of goods, was a notable exception to
this trend. It increased its key policy rate in three steps from 11.25%
to 12.75%, citing above-target inflation as its primary concern.
Among the major commodity-exporting economies, Russia was particularly
affected by the oil market turmoil. The rouble plunged 18% between
early December and late February, due to the combined effect of lower
oil prices, international sanctions and the corporate sector's large
foreign debt position.
The Russian central bank increased its key policy rate from 10.5%
to 17% in mid-December to shore up the currency, before lowering it
to 15% at the end of January.
The oil price plunge coincided with a continued appreciation of the
US dollar. From early December 2014 to early March 2015, the dollar
appreciated by around 6% on a trade-weighted basis. In particular,
it strengthened against the euro and the currencies of a large number
of emerging market economies, both commodity-producing and consuming
From the beginning of the sharp commodity price decline in early June
2014 to 4 March 2015, the dollar gained more than 12% in effective
Dollar strength primarily reflected a strong US economy. Average values
of manufacturing purchasing managers' indices (PMIs) in the United
States for December 2014-February 2015 were around those for the first
half of 2014, indicating a consolidation of strong economic activity.
At the same time, the outlook for economic activity remained weak
in many other economies, despite the drop in oil prices. Both the
World Bank and the IMF cut their global growth forecasts in January,
with the IMF's downward revision being its steepest in three years.
"Differing economic outlooks were reflected in further diverging
monetary policies, which fed through into foreign exchange markets.
Amid a flood of monetary easing by advanced economy central banks
in recent months, the Federal Reserve was the main exception."
According to BIS, US interest rate differentials vis-a-vis other advanced
economies increased along the maturity curve, supporting a strong
dollar against major currencies. Market participants continued to
expect that the Fed would start hiking its federal funds rate target
around the summer.
In contrast, the ECB provided additional monetary stimulus, which
pushed forward rates and the trade-weighted exchange rate of the euro
On 22 January, the ECB announced an expanded asset purchase programme
of around 1.1 trillion euros which encompasses existing programmes
for asset-backed securities and covered bonds, but also includes additional
purchases of bonds issued by euro area central governments, agencies
and European institutions.
Monthly purchases of 60 billion euros started on 9 March and will
run until at least end-September 2016, but may be conducted until
headline inflation is in line with the ECB's medium-term target of
below but close to 2%.
As the programme was larger and longer-lasting than market participants
had anticipated, asset prices rose, despite having rallied already
in the run-up to the January meeting of the ECB's Governing Council.
On the announcement date, stock prices of the main core and peripheral
euro area countries rose between 1.3% and 2.4%, while their sovereign
bond yields dropped.
The euro depreciated by around 1.5% against the US dollar, and estimates
of market-based inflation expectations edged higher, as reflected
by the increase in the five-year forward inflation swap rate for the
euro area. This indicator, which is closely watched by both the ECB
and market participants, fell back subsequently, but moved higher
again in the run-up to the March Governing Council meeting.
"At the same time, uncertainties about the policies of the newly
elected Greek government weighed on market sentiment. Concerns about
progress in negotiations between Greece and its creditors over the
terms of the bailout programme led to spells of volatility and drove
Greek sovereign yields to the highest level since July 2013. But contagion
was limited, with Italian, Portuguese and Spanish government bond
yields clearly decoupling."
BIS said that dollar strength and euro weakness prompted further rounds
of policy easing across the globe.
Pressures mounted, especially on exchange rates pegged to the euro.
The SNB, which had maintained a minimum exchange rate of CHF 1.20
per euro, introduced a negative interest rate (-0.25%) on large sight
deposits on 18 December in order to mitigate upward pressures on the
These tensions followed increased risk aversion and spikes in volatility
in global financial markets, which had propelled demand for safe assets.
The defence of the minimum exchange rate had caused the SNB's total
assets to surge to 87% of GDP in December.
Then, on 15 January, one week before the ECB announced its expanded
asset purchase programme, the SNB discontinued the cap, citing divergences
between the monetary policies of the major currency areas and dollar
appreciation as the main reasons behind its move. The central bank
also lowered its deposit rate further to -0.75%.
Financial markets reacted strongly to the removal of the cap. The
main Swiss stock index plummeted almost 9% on the day, and yields
on longer-dated Swiss government bonds fell below zero. The franc
dived to an all-time low against the euro immediately after the announcement,
before moving back to more stable levels later during the day.
Trading activity in EUR/CHF and USD/CHF spot markets shot up to levels
not seen since May 2010 and August 2011, respectively. Following the
SNB announcement, the Hungarian forint and Polish zloty weakened considerably,
driven by concerns about spillover effects of a stronger Swiss franc
to the Hungarian and Polish economies.
According to BIS, pressures on the Danish krone from a weaker euro
also started to mount. Danmarks Nationalbank lowered interest rates
on certificates of deposit four times in just three weeks to -0.75%
on 5 February, in order to defend the peg of the Danish currency to
"These easing central banks were not alone - in fact, well over
a dozen eased their policies during the past three months, against
the backdrop of the dis-inflationary impact of plunging oil prices
and increasing foreign exchange market tensions. The policy rates
of four central banks - the ECB and the central banks of Denmark,
Sweden and Switzerland - were below zero early in March. These moves
often surprised financial markets, fostering risk-taking and the search
for yield, which pushed up valuations of risky assets."
Dis-inflationary pressures prompted several central banks to ease.
With CPI inflation possibly falling below the 2016 target, the Reserve
Bank of India (RBI) surprised markets on 15 January by cutting its
main policy rate by 25 basis points to 7.75%, the first reduction
in 20 months.
The RBI surprised markets again on 4 March, lowering rates by another
25 basis points in an unscheduled inter-meeting move. The Monetary
Authority of Singapore (MAS) unexpectedly eased policy on 28 January.
It operates a managed float regime for the Singapore dollar under
which the trade-weighted exchange rate is allowed to fluctuate within
a policy band.
On 4 February, the People's Bank of China (PBC) unexpectedly announced
a 50 basis point reduction in the reserve requirement ratio for a
broad range of banks - the first industry-wide cut since May 2012.
Then on 28 February, the PBC lowered its benchmark policy rates, which
followed rate cuts in November 2014. The one-year benchmark deposit
and lending rates were reduced 25 basis points to 2.5% and 5.35%,
"Extraordinarily easy monetary policies fed through into unprecedented
conditions in bond markets. Government bonds across a wide range of
markets traded at historically low and often negative yields,"
Interest rates across the full maturity structure from two to 30 years
dropped to record lows for several European countries. The decline
was most pronounced for the longest maturities, with intra-day yields
on 30-year Danish, French and German bonds falling by around 60 basis
points, while those for Spain and Italy shrank by 90 and 100 basis
points, respectively. US 30-year Treasury yields fell to a historical
low of 2.2% at the end of January.
Many sovereigns' yields for maturities of up to five years, and for
Switzerland up to 10 years, sank below zero.
"At the end of February, around $2.4 trillion of global long-term
sovereign debt was trading at negative yields, of which more than
$1.9 trillion was issued by euro area sovereigns."
According to BIS, estimates indicate that the sharp fall in long-term
yields in the US and euro area was driven mainly by a compression
of term premia, and to a lesser extent lower inflation expectations.
Estimates of the term premium, i. e. the compensation for the risk
of holding long-duration bonds exposed to future fluctuations in nominal
rates, declined further into negative territory.
The drop in term premia may reflect a reach for duration in the face
of the ECB's expanded asset purchase programme and international portfolio
adjustment effects. At the same time, declining inflation expectations
in both the US and euro area were associated with falling oil prices.
The ECB's announcement that it would start full-scale quantitative
easing in March had an impact well beyond the markets immediately
affected. Historically low interest rates and compressed risk premia
pushed investors into riskier assets in their search for yield.
During the four weeks following the announcement, European equity
funds registered a cumulative inflow of almost $19 billion, the highest
amount ever recorded for a similar period. And the appetite for higher-yielding
corporate debt increased markedly as well, reflected by the largest
inflows into European high-yield corporate bond funds in a year.
"That yields in both the US and the euro area declined despite
diverging monetary policies in those economies points at possible
spillover effects from European bond markets to those in the US."
Indeed, said BIS, against the backdrop of a stronger US dollar and
increasing spreads between German and US sovereign yields, flows into
US Treasury bond funds for the week after the ECB announced its expanded
asset purchases were the highest since end-January 2014.
Overall, bond funds domiciled in the US saw historically large inflows
totalling around $40 billion during the four weeks after the ECB's
announcement - around three times the average inflow to these funds
for any four- week period in 2014. The large inflow comprised $15
billion of investments in corporate bond funds that was associated
with widening spreads between US and euro area corporate debt yields.
Flows into Emerging Market Economy (EME) funds were more muted amid
concerns about the growth outlook for Brazil, China and Russia.
"At the same time, this may also be associated with the attractiveness
of US assets as an option for international investors searching for
yield," said BIS.
"But average EME figures mask important differences across regions.
While emerging European and Latin American equity funds have registered
net outflows since the beginning of February, Asian equity funds have
attracted substantial inflows," it added. +