When FED pulls the plug Financing the Future International - - PowerPoint PPT Presentation

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When FED pulls the plug Financing the Future International - - PowerPoint PPT Presentation

Aug 12, 2023 328 likes •463 views

When FED pulls the plug Financing the Future International conference in honour of Niels Thygesen Jesper Berg, Member of Executive Board, Nykredit Bank 05-12-2014 If you put two economists in a room, you get two opinions, unless one of

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SLIDE 1

When FED pulls the plug

Financing the Future – International conference in honour of Niels Thygesen

Jesper Berg, Member of Executive Board, Nykredit Bank 05-12-2014

”If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.” Sir Winston Churchill on John Keynes

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SLIDE 2
  • Taper Tantrum (10th of June 2013 – 1st of July 2013)
  • The Greenspan Conundrum (2002-2006)
  • US Inflation Scares
  • The Long Run
  • A Comparison of the US/EU and Japanese financial crisis

Agenda

  • 15. december 2014

2

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SLIDE 3

Taper Tantrum

  • 15. december 2014

3

0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0%

US Treasuries

3Y US treasury bill 5Y US treasury bill 10Y US treasury bill 95 96 97 98 99 100 101 102 10-jun = 100

US Equities

S&P 500 Dow Jones Nasdaq 100 90 92 94 96 98 100 102 10-jun = 100

International Equities

MSCI Asia Pacific Index Stoxx Europe 600 FTSE Eurofirst 300 Germany Dax-30 KOSPI 14 15 16 17 18 19 20 21 $

VIX index

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SLIDE 4

The Greenspan Conundrum

  • 15. december 2014

4

0,0% 1,0% 2,0% 3,0% 4,0% 5,0% 6,0% 2002 2003 2004 2005 2006

US Treasuries

3Y US treasury yield 5Y US treasury yield 10Y US treasury yield Effective Federal Funds Rate 60 70 80 90 100 110 120 130 140 2002 2003 2004 2005 2006 jan 2002 = 100

US Equities

S&P 500 Dow Jones Nasdaq 100 50 100 150 200 250 2002 2003 2004 2005 2006 jan 2002 = 100

International Equities

MSCI Asia Pacific Index Stoxx Europe 600 FTSE Eurofirst 300 Germany Dax-30 KOSPI 5 10 15 20 25 30 35 40 45 2002 2003 2004 2005 2006 $

VIX index

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SLIDE 5

The US Inflation scare (Jan. 92 – Sep. 95)

  • 15. december 2014

5 2 3 4 5 6 7 8 9 Percentage Federal Funds Rate 30-year treasury

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SLIDE 6

The Long Run

  • Correlation between stocks and bonds
  • 15. december 2014

6

  • 0,8
  • 0,6
  • 0,4
  • 0,2

0,0 0,2 0,4 0,6 0,8 1,0 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

Correlation of Stocks & Bonds

2 4 6 8 10 12 14 16 18 500 1000 1500 2000 2500 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Percentage Index

10Y Treasury & Equity

S&P 500 (LHS) 10Y US treasury (RHS) 10 20 30 40 50 60 70

  • 0,4
  • 0,2

0,2 0,4 0,6 0,8 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 $

Correlation of Stocks & Bonds, the VIX index

Correlation (LHS) VIX-index (RHS) 0,0 0,5 1,0 1,5 2,0 2,5 3,0 2003 2004 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2013 2014 Percentage

Break-even inflation

US breakeven EU breakeven

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SLIDE 7

Comparison of US/EU & Japanese financial crisis

  • 15. december 2014

7

70 75 80 85 90 95 100 105 110 115 120

  • 5 -4 -3 -2 -1

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Years from onset of crisis

Real GDP

Japan (1991) United States (2007) Euro area (2007) 20 40 60 80 100 120 140

  • 5
  • 4
  • 3
  • 2
  • 1

1 2 3 4 5 6 7 8 9 10 Years from peak

Stock markets

US S&P 500 (Q2-2007) Euro Stoxx 600 (Q2-2007) Nikkei 225 (Q4-1989) US Quantitative Easing 1 (Jan. 2009)

  • 2%

0% 2% 4% 6% 8% 10%

  • 2
  • 1

1 2 3 4 5 6 7 8 9 10 11 12 13 14 Years from onset of crisis

QE and Benchmark rates

US QE (YoY), as % of GDP (Q3-08) JP QE (YOY), as % of GDP (Q1-90) Fed Target Funds Rate Overnight Call Rate US Zero Interest Rate Policy JP Zero Interest Rate Policy 20 40 60 80 100 120 140 160

  • 3
  • 2
  • 1

1 2 3 4 5 6 7 8 9 10 Years from onset of crisis

Corporate Profits

Japan (Q4-1989) US (Q2-2007) Germany (Q2-2007)

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SLIDE 8

From data to theory

  • 15. december 2014

8

Conundrum explanation?

Gordon’s growth model 𝑄

0 =

𝐸1 𝑠 − 𝑕 … if r’=g’ then p’=0

Explaining Inflation Scare and Japan? Expectation hypothesis: 𝑠𝑜 is the risk-free long term rate, 𝑠𝑛 is the short term rate and 𝜌𝑜,𝑛 is the term premium. 𝑠𝑢

𝑜 = 1

𝑙 𝐹𝑢[𝑠𝑢+𝑛𝑗

𝑛

] + 𝜌𝑜,𝑛

𝑙−1 𝑗=0

The risk-free rate i s driven by the sum of current and expected future short term rates plus the term premium. The term premium is mainly driven by inflation expectations.

Conundrum and Taper Tantrum explanation?

r is the discount rate 𝑠 = 𝑠

𝑔 + 𝛾(𝑠𝑛𝑏𝑠𝑙𝑓𝑒 − 𝑠 𝑔)

… the risk premium is correlated with VIX

Other explanatory factors

Risk-free rate = Real rate + Break Even Inflation Taylor’s Rule 𝑗𝑢 = 𝜌𝑢 + 𝑠𝑢

∗ + 𝛽𝜌 𝜌𝑢 − 𝜌𝑢 ∗ + 𝛽𝑧 𝑧𝑢 − 𝑧𝑢

, ℎ𝑤𝑝𝑠 𝑏𝜌,𝑧 > 0

Risk premium

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SLIDE 9

Summary

  • 15. december 2014

9

  • Central banks have become key players in financial markets
  • When they act and expectations change, markets move
  • If the world is good and the central banks act according to expectations

then the financial markets are likely to be in a good state

  • If the central banks fall behind the inflation curve, interest rates can

increase quickly

  • The average correlation between the long-term rate and the stock market

is negative, but fluctuations in the risk premium can create large positive correlation

  • If the Euro area goes ”Japanese”, we have other worries than a rise in

interest rates

  • Understanding risk-, term- and liquidity premiums, and the reaction

functions of central banks is important for our understanding of financial markets. “You can check-out any time you like, but you can never leave!” Eagles, Hotel California, 1976

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SLIDE 10

Bonus Slides

  • 15. december 2014

10

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SLIDE 11

The Federal Reserve (TOP) & ECB (BOT.) Balance Sheets

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11

  • 5,00
  • 4,00
  • 3,00
  • 2,00
  • 1,00

0,00 1,00 2,00 3,00 4,00 5,00

  • 5,00
  • 4,00
  • 3,00
  • 2,00
  • 1,00

0,00 1,00 2,00 3,00 4,00 5,00 januar 2008 marts 2008 maj 2008 juli 2008 september 2008 november 2008 januar 2009 marts 2009 maj 2009 juli 2009 september 2009 november 2009 januar 2010 marts 2010 maj 2010 juli 2010 september 2010 november 2010 januar 2011 marts 2011 maj 2011 juli 2011 september 2011 november 2011 januar 2012 marts 2012 maj 2012 juli 2012 september 2012 november 2012 januar 2013 marts 2013 maj 2013 juli 2013 september 2013 november 2013 januar 2014 marts 2014 maj 2014 juli 2014 september 2014 $Trillion $Trillion Bonds Loan, banks Loan, non-banks Currency swaps Mortgage backed securities Other assets Currency Reserves U.S. Treasury Other Liabilities Capital

Assets Liabilities

  • 3,5
  • 3,0
  • 2,5
  • 2,0
  • 1,5
  • 1,0
  • 0,5

0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5

  • 3,5
  • 3,0
  • 2,5
  • 2,0
  • 1,5
  • 1,0
  • 0,5

0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 januar 2008 marts 2008 maj 2008 juli 2008 september 2008 november 2008 januar 2009 marts 2009 maj 2009 juli 2009 september 2009 november 2009 januar 2010 marts 2010 maj 2010 juli 2010 september 2010 november 2010 januar 2011 marts 2011 maj 2011 juli 2011 september 2011 november 2011 januar 2012 marts 2012 maj 2012 juli 2012 september 2012 november 2012 januar 2013 marts 2013 maj 2013 juli 2013 september 2013 november 2013 januar 2014 marts 2014 maj 2014 juli 2014 €Trillion €Trillion Main Refinancing Operations Longer-term refinancing operations Other assets Deposit Facility Other liabilities

Assets Liabilities

Source: ECB & The Federal Reserve Bank.

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SLIDE 12
  • ”The slowing in the pace of purchases is akin to letting up on the gas

pedal as a car picks up speed rather than applying the brakes”.

  • ”(…) if the incoming data support the view that the economy is able to

sustain a reasonable cruising speed, we will ease the pressure on the accelerator by gradually reducing the pace of purchases. However, any need to consider applying the brakes by raising short-term rates is still far in the future”.

  • ”I would like to emphasize once more the point that our policy is in no

way predetermined and will depend on the incoming data and the evolution of the outlook as well as on the cumulative progress torward our

  • bjectives”.

Taper Tantrum – Ben Bernanke press conference 19th of June 2013

  • 15. december 2014

12

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SLIDE 13

Liquidity Premium – The syndrome of Lyngbyvej

  • 15. december 2014

13

  • The central banks have flooded the markets with liquidity and

thereby removed volatility

  • The liquidity premiums are historically low
  • The advantage of being liquid has fallen
  • Regulation has increased the costs of being liquid for market makers
  • The general pressure on deleveraging the financial system has

increased

  • The capacity of market makers is at an all time low
  • Is there a gap between the low liquidity premiums and the buffer

capacity of market makers?

  • How we in our effort to increase the resilience of

institutions reduced the capability of the system to absorb choks?