Mark Lister, 14 February 2016

For several years now, regardless of what sort of economic challenges appeared, financial markets have enjoyed the safety net of central bankers coming to the rescue. But in recent months, you get the feeling they are losing their touch.

In the US we had three successive rounds of money-printing after the global financial crisis. In Europe, there was the famous "whatever it takes" speech by European Central Bank (ECB) President Mario Draghi. Japan has thrown the kitchen sink at its weak economy and stubbornly low inflation, while just about everyone else has reduced interest rates as much as they can, theoretically.

However, over the last few months we've seen some strong words and even stronger actions go almost unnoticed by financial markets.

Back in December, the ECB extended its asset purchase programme, broadened the range of things the programme can buy, cut its deposit rate further into negative territory, and stated that it would do more if necessary.

That all sounds pretty generous, but markets were underwhelmed. European shares were sold off and the euro had its largest one day gain against the US dollar since 2009.

At the time, many people wrote that off as misplaced optimism in the lead up, making a set of otherwise impressive measures not good enough. But the trend of increasing central bank impotence has continued this year.

Last month, the Bank of Japan (BOJ) unexpectedly cut a key interest rate to below zero for the first time ever, sparking a rally in global shares and sovereign bonds, while causing the yen to fall heavily. Governor Kuroda told a news conference the BOJ will do whatever it takes to get inflation higher, including cutting rates further into negative territory.

The enthusiasm was short-lived and several days later, Japanese shares were heavily sold off, the yen was rising again and interest rate spreads were increasing. Worried investors are now demanding higher rates from risky borrowers, while the flight to safety has pushed the rate on safer bets like Japanese and German government bonds below zero.
The focus will soon shift back to the heavyweight of central banks, the Fed. After the historic move to end nine years of zero interest rates, a slew of mixed economic data and nervous financial markets will probably force the Fed to backtrack on plans for further increases this year.

Furthermore, for the first time ever, the Fed and other authorities have now asked the US banks to run scenarios for negative interest rates. While this is only hypothetical at this point, we would've said the same about negative rates in Europe and Japan a few years back, or regarding the probability of printing US$85m a month in the pre-QE days.

I don't envy our own Reserve Bank at all, with these sorts of shenanigans going on offshore. The RBNZ won't want to cut the Official Cash Rate (OCR) any more if it can avoid it, and it would likely take an economic turn for the worst as well, rather than low inflation alone.

However, if the bigger players continue to find innovate ways to take further action, maybe we'll need to follow suit just to stand still. In contrast, given the heavy reliance on overseas borrowing to fund our housing enthusiasm, we could see those increasing credit spreads eventually find their way to our shores in the form of higher rates.