Central Banks Commit to Ease as Threat of Lost Decades Rises

Another round of loosely correlated global stimulus has
begun after the Federal Reserve extended its Operation Twist
program and counterparts from Japan to Europe consider more
monetary easing of their own.

The rub is that even as they renew their rescue efforts,
policy makers are postponing forecasts for fuller recoveries and
run the risk that their latest actions pack a smaller punch.
This raises the prospect of longer-term anemic expansion akin to
the doldrums Japan has suffered since the early 1990s.

“Japan’s experience shows central banks can mitigate the
worst effects of the current environment, but it’s going to be
very hard for them to stimulate demand,” said Peter Dixon,
global equities economist at Commerzbank AG in London. He
predicts a lengthy period of “sluggish growth and high
unemployment” in the debt-ridden industrial nations.

The combination of economic weakness and policy
indecisiveness leaves Jan Loeys, chief market strategist in New
York at JPMorgan Chase & Co., recommending gold and U.S. assets,
on the hope of greater quantitative easing, and shying away from
peripheral Europe’s bonds and stocks that traditionally benefit
from output growth.

Ready for More

Investors should “position for further monetary action,
even if it doesn’t do enough,” said Loeys, whose colleagues
anticipate worldwide expansion of 1.4 percent this quarter –the
weakest since the end of the 2009 recession.

One drawback is that the central banks with the most
ammunition, such as the European Central Bank and some in
emerging markets, are hesitant to act, he said. India
unexpectedly chose not to reduce its 8 percent benchmark
repurchase rate last week, while Loeys notes other developing
nations aren’t cutting because their currencies have weakened
and they fear creating asset bubbles.

“From a global point of view, those willing to do
something probably don’t have a lot of impact, and the rest who
can do something are reluctant,” he said.

Five Years In

Almost five years after central banks first sprang into
action to buoy the world economy, they are being forced to react
to a third successive annual fading of recovery hopes as
Europe’s debt crisis threatens to engulf Spain and Italy, hiring
in the U.S. stalls and China slows. A June 1-5 poll of
economists by Bloomberg News found the median estimate for
growth worldwide this year falling to 3.2 percent from the May
forecast of 3.4 percent.

Developed economies are running into the limits of monetary
policy, the Bank for International Settlements said in its
annual report yesterday. Central bank balance sheets now contain
$18 trillion of assets, about 30 percent of global gross
domestic product, double the ratio of a decade ago, and interest
rates are as “low as they can go,” the BIS said.

Governments have “cornered” central banks into prolonging
stimulus, and have dragged their feet on restoring fiscal order,
said the Basel, Switzerland-based BIS, which holds currency
reserves on behalf of global central banks. Monetary policy only
“buys time” in the short run for leaders to act, and leaving an
easy stance for a prolonged period poses economic risks, it said.

Lower Profit

Memphis, Tennessee-based FedEx Corp. (FDX), operator of the
world’s largest cargo airline, said last week that first-quarter
profit will be lower than analyst forecasts amid slowing global
expansion. Profit excluding some items for the three months
through August will be $1.45 to $1.60 a share, compared with an
average estimate of $1.70 from 16 analysts surveyed by Bloomberg.

The slow growth has helped blunt any inflationary threat.
Oil tumbled last week below $80 a barrel for the first time in
eight months, and commodities entered a bear market as the
Standard & Poor’s GSCI Index of 24 raw materials fell to its
lowest level since October 2010.

Fed Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner have argued that the world’s largest economy won’t
suffer a fate similar to Japan, partly because U.S. policy
makers have been quicker to act to promote expansion and bolster
the banking system.

Reduced Forecasts

Even so, both the Fed and White House repeatedly have
scaled back growth forecasts since the recession ended in June
2009. The latest cut came last week, when the central bank
lowered its projections for this year and next. Fed officials
cut their central-tendency estimate for 2012 gross domestic
product growth to 1.9 percent to 2.4 percent from 2.4 percent to
2.9 percent in April. Estimates for 2013 are for 2.2 percent to
2.8 percent, compared with 2.7 percent to 3.1 percent.

“Like many other forecasters, the Federal Reserve was too
optimistic early in the recovery,” Bernanke said at a June 20
press conference, citing, among other things, headwinds from the
turmoil in Europe, still-tight credit for many borrowers and
budget cuts by state and local governments.

The U.S. has grown about 0.2 percent on an annual basis
since 2008. In inflation-adjusted terms, GDP per capita in 2011
was 2.4 percent below 2007, according to International Monetary
Fund data. The recession began in December that year.

The Fed responded last week by extending its Operation
Twist program through year-end, pledging to swap $267 billion in
short-term securities with longer-term debt. Bernanke also
signaled that the central bank is inclined to do more to spur
growth should the recovery falter further or unemployment start
to rise. The jobless rate has been above 8 percent since
February 2009.

‘Serious’ Risks

The ECB also is downgrading its outlook before meeting on
July 5. President Mario Draghi said June 15 the 17-nation
economy faces “serious downside risks” and conditions have
worsened since the ECB estimated June 6 that the euro zone would
contract about 0.1 percent this year. The central bank ended
last year projecting growth of about 0.3 percent, a percentage
point lower than it forecast in September 2011.

A contraction of about 0.5 percent is more likely,
according to new forecasts from BNP Paribas SA. Manufacturing
output shrank at the fastest pace in three years in June, data
showed last week.

That backdrop is enough for policy makers to cut their key
interest rate by 25 basis points next week to a record low of
0.75 percent, said Ken Wattret, chief euro-zone market economist
at BNP Paribas in London. He isn’t ruling out a deeper reduction
— or the ECB cutting its 0.25 percent deposit rate to prompt
lenders to loan more — if European leaders meeting in Brussels
June 28-29 devise a stronger response to the debt crisis.

Helping at Margin

“Is it going to turn the economy around? Clearly not, but
every little thing helps,” Wattret said.

Attendees at the summit will discuss ways to better
integrate their currency bloc by pursuing closer fiscal ties,
adopting initiatives to bolster growth, providing stronger
supervision and reinforcement for banks and perhaps issuing
joint debt at some point.

Bank of England Governor Mervyn King will push at the July
5 meeting for more stimulus after being defeated 5-4 in a vote
this month against greater so-called quantitative easing. King
backed increasing asset purchases by 50 billion pounds ($78
billion) and said June 14 that the central bank will activate a
sterling-liquidity facility to aid banks and start a credit-
easing operation that may boost lending by 80 billion pounds.

Recession Relapse

HSBC Holdings Plc and Societe Generale SA now predict the
BOE will announce an increase in purchases next week, having
previously said the bank would wait. The U.K. flopped back into
recession in the first quarter, and King describes the euro
crisis as a “black cloud” hanging over the world economy.

Bank of Japan policy makers also will review their
projections when they convene July 11-12, three months since
they forecast GDP would expand 2.3 percent and inflation
excluding fresh food would accelerate 0.3 percent in the fiscal
year that ends next March.

Analysts from UBS AG to Jefferies Japan Ltd. predict the
BOJ will boost its asset-purchase program from the current 40
trillion yen ($498 billion). Board members may add more risk
securities such as exchange-traded funds and corporate debt,
along with government bonds, according to JPMorgan Chase.

The worry for international policy makers is that Japan’s
recent past reflects their future. Its economy stagnated in the
early 1990s after the BOJ boosted borrowing costs to rein in a
surge in inflation, real-estate and equity prices. With banks
hobbled by bad debt from the bursting of the asset bubble, the
BOJ lowered its main rate to near zero in 1999.

Japan’s Woes

After flooding the banking system with cash from 2001 to
2006, the central bank now has deployed its second round of
quantitative easing. The moves haven’t ignited growth, with GDP
rising at an average rate of 0.75 percent in the past 20 years,
according to International Monetary Fund data. Consumer prices
fell in eight of the past 13 years, and inflation hasn’t
exceeded 1 percent since 1997. Unadjusted for price changes, the
size of the economy last year was the smallest since 1990 and
had contracted 10 percent from its peak in 1997.

ECB economists say the U.S. and euro-area are “rather
unlikely to tread the same path of Japan” because they had
different pre-crisis debt imbalances, according to their May
monthly bulletin. Japan’s experience nevertheless demonstrates
the importance of repairing financial sectors before trying to
generate a sustainable recovery and shows that delaying reforms
may mean fragile economic growth, they wrote.

Packing Punch

Central bankers say they still pack a punch.

“I wouldn’t accept the proposition” that the Fed “has no
more ammunition,” Bernanke told reporters June 20. “I do think
that our tools, while they are nonstandard, still can create
more accommodative financial conditions, can still provide
support for the economy.”

At London-based hedge fund SLJ Macro Partners LLP, managing
partner Stephen Jen said he fears “we may be four years into a
decade-long global crisis,” adding that rather than a lost
decade, Japan now has suffered a lost generation.

Jen, a former IMF economist, questions the power of easier
monetary policy and says officials must take a longer-term view
and ensure their economies live within their means rather than
continue dispensing short-run aid. While quantitative easing can
boost equities and cap interest rates, costs include fanning
medium-term inflation, sparking financial volatility and
encouraging complacency among governments on structural and
fiscal reforms, he said.

“After four years of policies centered around demand
rather than supply, I suspect the world could be further away
from a lasting solution to the crisis,” he said. “A series of
short-term solutions could lead to the wrong long-term
solution.”