Central banks’ wait and see strategy
THE BANK of Japan last week stunned most markets by not taking any further steps to stimulate the weak Japanese economy.
There are at least two possible explanations for this latest action. The first assumes a strategic move to wait for the full impacts of the negative rate of credit expansion in Japan. This is due to the negative interest rate set for commercial-bank deposits at the BOJ, which induces commercial banks to lend more in order to avoid higher costs of deposits.
The second explanation is that the BOJ wants to wait for the outcome of the US Federal Reserve’s next meeting in June on whether to raise its policy interest rate.
In addition, the negative interest rate may create investment distortions that should be closely monitored. More major Japanese insurance companies are switching to invest in private companies’ bonds in the United States because they want to get higher returns than investing in local bond markets. Many European investors have done the same, for the same reasons.
These factors have reduced the margin between the yields of private US bonds and government bonds with the same maturity (or credit spreads). Normally, narrower credit spreads would have meant that private US companies had a lower risk of bankruptcy. However, the VIX index (which is a measurement of expected equity-market volatility over the next 30 days) has surged in the opposite direction of the changes in credit spreads.
These contradicting signals, therefore, can create a lot of doubt about the strength of private US companies. In other words, the recently narrowing in credit spreads in the US is actually caused by the excess demand from foreign fixed-income investors, mostly Japanese and European.
The main reason the BOJ is waiting for clarity on any policy-rate increase at the next meeting of the Fed is that this decision could indirectly reflect the degree of recovery risks for the US economy. It is also a signal for the BOJ to decide what to do next with its negative-interest-rate policy.
Thai investors who want to put more money into foreign fixed-income markets as well as other more risky asset markets should, therefore, ensure that they have a thorough understanding of the recovery risks of both the US and the world economy.
The decision of the Bank of Thailand this week to maintain its policy rate is also consistent with the current “wait and see” strategies of the Fed and the BOJ.
Professor Arayah Preechametta is a lecturer at the faculty of economics, Thammasat University.
