How Does All The Government Aid End?

Blomberg had a good piece over the weekend about differing strategies among global central banks. Specifically how will each region end accommodative rate policy? The crux is that central banks have to eventually unwind two things: rate cuts and asset purchases. The latter is what has driven rates down in the U.S. From just after the credit crisis began in August 2007 to November 2008, the Fed cut overnight rates from 5.25% to 1%. When that did nothing for long-term rate relief, the Fed announced (before Thanksgiving 2008) they’d start buying up to $1.25t in mortgage bonds to bring rates down.

It worked like gangbusters, and the cheap money party still goes on today almost a year later. This is why we see the occasional story about exit strategy. We covered the Fed’s exit strategy when they announced it late-July, which reviewed all the options the Fed has to unwind low rates and mortgage bond holdings—the most probable two options are selling mortgage bonds and hiking rates, likely in that order as the economy improves. Here are some highlights from Bloomberg’s story:

…The analysis suggests the Fed regards interest-rate increases as being enough to unwind stimulus without bond sales, while the Bank of England may want to raise rates and sell assets concurrently. Both banks have amassed billions of dollars in debt holdings after they cut interest rates close to zero to battle the global recession.

In the U.K. central bank’s view, “to raise the short-term interest rate while never selling the bond holdings would be to tap the brake while the other foot remained firmly on the accelerator,” McCauley said. For the Fed, “without a foot on the accelerator, one could consistently tap the brake.”

The BIS, the bank for central banks, published the report as part of its quarterly review of the world economy.

…The U.S. central bank has signaled it may not raise rates first, and instead may adopt actions such as providing short- term repurchase agreements against long-term securities, McCauley wrote.

The Bank of England on Sept. 10 reiterated its program to buy 175 billion pounds ($292 billion) of bonds with newly created money as it kept the benchmark rate at 0.5 percent.

Deputy Governor Charles Bean signaled last month that the U.K. central bank will probably use a combination of interest- rate increases and asset sales in withdrawing stimulus.

“The fact that we can raise bank rate means that we can stagger sales back to the private sector in a way that recognizes market conditions at the time,” he told journalists in London. Prospects for inflation will be the “guiding light” that determines the timing of any withdrawal, he said.

The Swiss National Bank, which has been pursuing a policy of holding down the Swiss franc by buying foreign assets, has offered little guidance on how it will exit this strategy, McCauley said.