How Low (and, Strangely Enough, High) Can the PBOC and Other Central Banks Go?


The aftermath of the Covid-19 situation made at least one aspect perfectly clear: governments and especially central banks do not intend to let the economic dimension of the crisis simply run its course and, on the contrary, have manifested a more than obvious intention of proverbially throwing the kitchen sink at the problem.

The Beijing authorities, in tandem wit the PBOC, have been the first to aggressively provide stimulus, in an effort to strongly combat the economic effects of what ultimately became a pandemic. They were the first to do so for one simple reason: the fact that problems first appeared in China, it has nothing to do with China somehow choosing to be more aggressive than anyone else from an economic perspective. From a crisis management perspective, of course, that changes but this article refers exclusively to economic implications and especially the monetary dimension.

As time passed and the virus spread to other countries, a common denominator became easily identifiable among central banks: their willingness to act quickly and very aggressively. For example, over in the United States, the Federal Reserve’s first response in terms of interest rates was a 50 basis point cut, with them then relatively quickly thereafter cutting all the way down to zero. To put it differently, interest rates which had barely been increased to the 1.5% – 1.75% zone quickly went down to 1% – 1.25% and ultimately to… well, zero. This is just the interest rate dimension, with the Fed also offering mountains of liquidity, from repo facilities to the $700 billion Quantitative Easing process set in motion after bringing rates down to zero. In other jurisdictions, things are even trickier, for example in light of the fact that in the European Union, European Central Bank rates were already negative.

How low can central banks go?

It depends on:

  1. Whom you ask
  2. How markets perceive the country or jurisdiction in question

What does it mean that it depends on whom you ask? Let’s just say that among economists, a case could be made that the most popular opinions revolve around the idea that being unprecedentedly aggressive is the way to go or, to put it differently, around the idea that central banks can get away with pretty much anything, including going deep into negative territory. On the other end of the spectrum, there are those who believe that no, that is impossible, in light of the fact that while the average depositor might accept paying the bank 0.1% to keep his or her money, that same depositor will simply withdraw if the 0.1% turns into let’s say 3%. Again… opinions vary wildly.

When it comes to the second observation, yes, it is indeed very important to state that not all central banks “get away” with the same level of stimulus. Think of it as a spectrum with two extremes. On the one end, you have the world’s #1 safe haven destination which is (still) the United States and as such, the Federal Reserve can get away with quite a bit in terms of policy aggressiveness. On the other end of the spectrum, we have the world’s poorest nations, which would quickly lose market access (assuming they even meaningfully have it to begin with) should their central bank become overly aggressive, there is a reason why such countries sometimes simply peg their currency to the dollar.

Where does China stand?

Well, somewhere in-between of course, getting closer and closer to the United States as time passes but it is not yet there yet, nor is it at parity with nations such as Germany and Japan in terms of being considered a safe haven destination. For example, 10-year bond holders are paying Germany (negative return) and happy to do so, whereas that is just not the case with China. As such, until this dynamic changes and China ends up perceived as a safe haven destination, markets will be a lot quicker to punish China as a result of what it perceives to be overly aggressive PBOC actions than the United States or Germany.

Finally, what does the “how low (and, strangely enough, high)” statement found in the title actually mean? Simple, it refers to the fact that at the same time, central banks have to go low (by lowering interest rates as long as the market permits it) and high (proverbially pumping money into the system through monetary easing, purchasing a wide range of assets, etc.) at the same time in what might end up representing a remarkably complex juggling act.

At this point in time, markets don’t seem all that keen on punishing central banking “recklessness” and on the contrary, they expect more and more of it. For example, the market was clearly disappointed by the fact that initially, the Federal Reserve “only” lowered (already low) interest rates by 0.5% and even more so, it seems that for this specific crisis, it is expecting far more on the fiscal stimulus front as well.

It ultimately remains to be seen at what point, if at all, the market will state that enough is enough. For the time being, this much is certain: markets most definitely expect to once again be “saved” by the authorities, with them demanding much more in the way of fiscal stimulus this time around, also in light of the fact that central banks have less ammunition at their disposal than during previous cycles.

At the end of the day, nobody knows how low/high central banks can go, especially if we also think about the fact that let’s say 20 years ago, even the idea of negative interest rates would have seemed ludicrous. As such, it would (in the opinion of the team, at least) be wise to prepare for the possibility that central banks might end up being far more aggressive than anyone would have expected but at the same time, that they might eventually take it so far that the market ultimately says no. That, however, is a topic for a future article.

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