Here Is Why Competitive Easing Is Not A 'Zero Sum Game' - Goldman Sachs

[thenews]

In advanced economies, attempts by central banks to reflate are increasingly seen as yielding lower benefits (or even costs, as in the case of negative rates) and ‘competitive easing’ by the major central banks is seen as a ‘zero sum game’.

But there are two dimensions which the dominant narrative often omits.

First, the ECB’s and the BoJ’s ongoing QE programs have fiscal effects, both from a flow and a stock side, as we wrote about here. Bond purchases allow governments to run larger primary deficits (by cutting taxes or increasing spending) without the associated absorption of savings 'crowding out' private sector borrowing. More could be done along this dimension: economic theorists have long argued that at the zero bound fiscal expansions (particularly those centred on tax cuts) are desirable. But discretionary counter-cyclical fiscal policies are now in place both in the Euro area and Japan. We expect government net expenditure to contribute as much as 50bp to real GDP growth this year in both regions. It is also important to note that both principal and coupons of the securities that end up on the central banks’ balance sheets will be reinvested for some time after purchases end. This implies that for a number of years debt roll-over will decline.

Second, although it is harder to move currency pairs in the advanced economies, and in any case the pass-through effects are small, local costs of borrowing are in the aggregate coming down fast. Long-dated government bond yields and swap rates in the G-7 economies (in both nominal and inflation-adjusted terms) are now at the lowest they have been in this entire recovery. This is, in turn, translating into increasingly accommodative private lending conditions. Take a country like Italy, where lending rates have been stubbornly high. Between June and December of 2015, the rates charged to new loans for house purchases have fallen by 50bp to 2.2% at the 1-to-5-year maturity, and to 2.8% for maturities beyond 10-years. These levels are within 50bp of those prevailing in the core countries, according to data published by the ECB. Interest rates charged to new loans to non-financial corporates are close to 1.9% for amounts in excess of EUR1mn and 1-to-5-year maturity, very close to the corresponding rate in Germany and France. In the UK and the US, both mortgage and C&I loans are making new lows.

So what about the fall in stock and corporate bond prices? While currency moves shift growth and inflation profiles across regions, the decline in the value of claims on firms are very synchronous across regions, result in negative wealth effects, and dent business and consumer confidence. Policy makers have already voiced concerns over the tightening of financial conditions and, in response, our US team has earlier this week pushed out the timing of the next Fed hike from March to June. But some perspective when looking at these dynamics is also needed.

Central banks have spent the good part of 7 years purchasing assets and injecting liquidity. In 2013 the baton passed from the Fed to the BoJ and in 2014 the ECB also joined the relay. The resulting increase in global liquidity has progressively inflated asset price valuations, starting with high-quality government bonds to stock prices, real estate. As we came into the Fed’s ‘lift off’ last December, long-dated US Treasuries stood at the most expensive levels (in relation to consensus expectations on future growth, inflation and policy rates) relative to the previous four tightening cycles, as shown in the accompanying exhibit.

...Pessimism in asset price returns can prove self-fulfilling, and needs to be watched. But several macro assets were ahead of their underlying fundamentals, and a realignment of relative returns as US cash rates slowly rise in response to (not ahead of) rising inflation is underway.