Central bank intervention, lessons learned from past crises, and the current U.S. coin shortage are topics of discussion today with Dr. Brian Jacobsen, Senior Investment Strategist for the Multi-Asset Solutions team at Wells Fargo Asset Management.
John Natale: I’m John Natale and you are listening to the podcast, On the Trading Desk®. Today’s topic: Central bank intervention. We’ll look at how the U.S. Federal Reserve and central banks in other major economies are approaching the current environment in light of the pandemic and the path to recovery. Our guest is Dr. Brian Jacobsen, Senior Investment Strategist for the Multi-Asset Solutions team at Wells Fargo Asset Management. Brian, welcome back to On the Trading Desk. How are you doing?
Brian Jacobsen: I’m doing well. Thank you so much for having me back.
John: Glad to hear it and definitely looking forward to today’s discussion with you. So, Brian, let’s start here. You recently published a piece about central bank actions titled, In a sea of stimulus, will major economies swim on—or sink in debt? The piece, which listeners can find on our AdvantageVoice® blog, explores the global stimulus efforts in the COVID-19 era.
With central bank balance sheets and government debt on the rise, you noted that the sea of stimulus has caused many investors to worry about whether economies could drown in debt. So for this episode, can you please expand on this topic and share some of your key findings with our listeners?
Brian: Yeah, I’d be more than happy to. And going into 2020, investors were already worried about two things when it comes to government debt and then central bank activity.
When it comes to government debt, people were already kind of worried about the level of the debt to GDP for a number of developed economies, like the United States or Japan, as two prime examples, and then also the deficit spending. So deficit spending is almost like the addition to the debt every year. And one of the concerns was that the U.S. federal government and other governments as well, but mainly in the U.S., that we are running very high levels of deficit relative to GDP that we typically don’t see during economic expansions. And so it was kind of a worry about well, what if something happens, is there any fiscal capacity to increase spending?
And then on the central bank side, one of the concerns was interest rates are still really low. Central bank balance sheets are still very large because of past interventions, or in some cases, continuing interventions in the markets. So were they are out of room to maneuver? And then along comes the coronavirus crisis and well, I guess they weren’t out of capacity. We suddenly had, I think in the United States, we’re on like Phase 3 of fiscal stimulus. The Federal Reserve very quickly cut their overnight target interest rate to 0% and started more quantitative easing. So it really motivated the writing of the piece was the kind to just think through there were already these concerns going into the coronavirus crisis and then they almost just got compounded as we have gone through — and now are hopefully emerging — from that crisis.
John: Interesting. Definitely good piece to check out. So getting back to the overall topic, we know that central banks intervene through rate policy and the things they purchase. But as central banks use these key elements of their toolkits, what do you find interesting about this wave of recovery efforts versus in past times of crisis?
Brian: I think one of the key things that sticks out to me is how this might not have been perfectly coordinated across central banks, but it sure looked like it.
In quick succession, you had the U.S. central bank, the Federal Reserve, cutting interest rates and then engaging in additional asset purchases and then other countries very quickly followed suit.
But then it also looks like there’s a lot more coordination with fiscal authorities this time than in previous crises. Just thinking back to the financial crisis in 2008, one of the things that the Federal Reserve and other central banks have oftentimes talked about is how they are independent of their treasuries of the fiscal authority, because they don’t want investors or the public to think that the government can issue whatever debt they want and the central bank will just buy it all up.
And in the financial crisis, very early on, it was made very clear that hey, we’re not coordinating. We’re not just trying to quote unquote “monetize” the debt.
Well, this time seemed to be a little bit more coordination much earlier on with the treasuries in the sense that the U.S. treasury had a number of programs that were approved by Congress and signed into law that gave the treasury authority to effectively absorb some credit risk to go out and establish different programs to purchase, say, corporate bonds.
And then the Federal Reserve was empowered by Congress and signed into law by the president to basically lever that up. So that was I think one of the most notable differences this time compared to previous episodes is just that coordination.
John: That’s interesting, and I’m glad that you brought up some historical context on how the Fed has acted in the past.
So let’s keep talking about the Fed. I’m wondering what can the U.S. central bank’s actions during previous crises tell us about what today’s Fed absolutely must get right now, in your view?
Brian: Clear communication is something that central banks really need to focus on, because of how sometimes market participants can be over-interpret or misinterpret what is said by central bankers.
That can have some rather profound consequences as far as financial stresses, which then can have real economic costs. So clear communications of their intentions.
I remember back to 2013 when Chair Ben Bernanke of the Federal Reserve, he had floated the idea that the Fed’s asset purchase programs, at that point, effectively could come to an end at some point.
If you read what he actually said, it seemed kind of obvious that yes, at some point they will have to stop the asset purchase programs because the economy will be doing just fine.
Well, the market heard that and we had what is now called the “taper tantrum” where yields jumped rather materially. The stock market sold off and it caused a few months of a lot of market volatility and tightening of financial conditions basically because he was stating the obvious.
But he did it probably a little bit earlier than what people were expecting, and that’s one of the reasons why the Federal Reserve made changes to their policies after that to better communicate with the public what their intentions are.
So now they’re providing a summary of economic projections. So that’s kind of a way for them to really try to communicate more clearly what their intentions are, but a slight slip of the tongue can cause kind of a slippery slope for the stock market or it could cause some real constriction in the credit markets.
John: That makes perfect sense. Good. So I was wondering if you can provide your take for listeners, what should investors be watching closely when it comes to how central bank intervention might eventually affect their portfolios?
Brian: Sure. I think that really it has helped already.
It was on March 23 was a low for the S&P 500, and I don’t think it’s any coincidence that that was the day after the Federal Reserve announced that they were basically going to be doing as much quantitative easing or asset purchases as necessary. And in quick succession, other central banks followed suit. So investors probably have already experienced some of that intervention and what the effects are on their portfolios.
But when it comes to anticipating when the Federal Reserve might find that the coast is clear, I think a key thing that we’re watching is a gauge of market expectations of future inflation, which can be reflected in things called treasury inflation protected securities. From those, you can get what are called break-evens, which is the rate of inflation at which it’s kind of a tossup between buying your typical treasury security or an inflation-protected security. And so if that break-even yield is moving higher, and in our estimation if it’s getting closer to the Fed’s target of 2%, that means that the market is probably expecting that inflation is beginning to pick up, and if it gets too much above that, then it’s maybe a signal that the Fed is going to take notice and they might need to start withdrawing some of that stimulus.
So I think that as far as a real time indicator to keep an eye on, it would be those break-evens and to see if they’re staying well-behaved or if you’re beginning to see a lot of volatility there.
John: Thank you. Thank you. I suspect that’s going to be useful for our listeners. So there’s another dimension of central bank action that you and I haven’t discussed yet. It pertains to currency, but specifically at the penny, nickel, dime, and quarter level. I read that the U.S. is facing a nationwide coin shortage, and there’s a 22-member Federal Reserve task force that’s designed to tackle this problem.
So Brian, can you tell us more about this and perhaps even its historical significance?
Brian: Yeah, sure. Actually, it’s pretty fascinating. So this is about coins no longer really, I guess, circulating as quickly as what they use to.
It was almost like this interesting confluence of events because in most recessions, people will take out their coins and take them to the bank and they want to spend those, right? It’s kind of their rainy day fund, in a way. But people just didn’t do that this time. It might be an issue as far as how you take those to the bank. When I first started in the financial services industry back in the 1990s, I was a teller at a small local bank, and we wouldn’t take those through the drive-thru. A lot of people are now going only through the drive-thru because they don’t want to go through the lobby. So how do you take them?
And plus, money itself, whether it’s coins or the cash, it’s filthy. It’s oftentimes very dirty, and I think some people are kind of concerned about that.
So I think you just have this weird situation as far as with retail shutting down, the traditional places where coin would enter into the economy and circulate it, because that got all plugged up, we got a little bit of a shortage. But my guess is as reopening plans continue, that coin shortage will eventually go away.
John: Thanks for going into detail there. I think if the task force ever calls on all of us to do our part, I suspect that quite a few of us probably have one of those jars full of coins that’s been accumulating over the years. Perhaps we can all pitch in.
So I appreciate your time. Again, Brian, it’s always informative and enjoyable to hear your thoughts on the latest macroeconomic developments. So I thank you for joining us on the podcast once again, Brian.
Brian: Thanks so much for having me. It’s always fun.
John: This wraps up another episode of On the Trading Desk podcast. If you’d like to read Brian Jacobsen’s recent commentary—again titled, In a sea of stimulus, will major economies swim on—or sink in debt?—you can visit AdvantageVoice, the official blog of Wells Fargo Asset Management. To our listeners, thank you again for taking the time to listen. We know that time is precious these days and as always, we appreciate you joining us. So until next time, I’m John Natale. Be well.
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