Swiss megabank UBS, one of the great beneficiaries of the Fed’s policies, ponders in its latest FX Comments how to deal with asset bubbles, “most importantly in housing markets,” a topic that is a “hotly debated issue among central banks.”
Turns out, after nearly six years of printing money and inflicting ZIRP and financial repression on most developed economies, thus creating these asset bubbles in the first place, central bankers find themselves “essentially in an experimental phase.”
Shouldn’t they have thought about this before? It seems. But publically, the Fed and other central banks are still vociferously denying that there are any asset bubbles. In fact, the Fed prides itself in having “healed” the housing market: prices in many cities, including San Francisco, are now substantially higher than they were at the craziest peak of the last housing bubble.
So in this environment of pandemic central-bank bubble-denials, UBS writes that “policymakers around the world are struggling with potential asset bubbles” that are “a logical and inevitable consequence of historically unprecedented monetary policies.”
It took nearly six years to figure this out? The report goes on:
Asset prices have indeed in many cases reached stunning levels, quite obviously out of line with ‘fundamentals,’ for example in credit or government bond markets. The most dangerous of bubbles are deemed to be those in housing markets as their bursting could wreck whole economies.
Given central-bank focus on enriching those who hold financial assets, identifying asset bubbles is, according to UBS “notoriously difficult.” In fact, it’s larded with risks: once central banks officially identify asset bubbles – not just a little “froth” – they have to do something about them or lose what is termed, as if it had been a great insider joke all along, their credibility.
But from the point of view of those who hold these bubbly assets, there is never a right time. They’re their wealth bubbles that would get pricked. So “tolerating them for a bit longer might look tempting given the risk of pricking them at the wrong time,” UBS muses.
But even the IMF, the official international bondholder bailout organ, had warned in June that “the era of benign neglect of house price booms is over.”
So how can central banks stop these bubbles they created, while denying that they exist, and even if they did exist, that central banks created them? It’s a bit of a quandary.
One option would be to stop printing money and raise interest rates, the classic maneuver, “which would typically have been seen as the first, and possibly only, line of defense,” UBS explains wistfully. But it would wreak all sorts of havoc on the financial markets and deflate the wealth of those who’ve benefited from the money-printing binge. UBS explains it this way: “with economic activity levels still seen as too fragile in most major countries, central banks have been searching for substitutes.”
Hence, “macroprudential” measures, such as imposing stiffer requirements on mortgages. Currently, “an intense debate” is transpiring among central bankers about “the effectiveness of such tools and their interaction with more traditional monetary policy” – with policymakers “more often than not hoping to thereby delay having to deploy the blunter tool of interest rate hikes.”
Hoping. Because no one knows; they’re all just “experimenting.”
The report discusses the different approaches: the Bank of England “underwhelmed markets” with its “muddled” message on how to deal with ballooning home prices; the Reserve Bank of New Zealand, among the first to warn of house price inflation, has a “mixed experience.” The Swiss National Bank “has no choice but to rely on macroprudential measures” and can’t raise interest rates as long as it is maintaining its EURCHF floor.
Then there’s the Fed, “a remarkable dovish outlier.” Instead of focusing on the incredibly ballooning home prices and citing them as a reason for what might count as monetary policy normalization, it has been warning, ironically, of slowing sales volume. Ironically, because slowing sales are a direct consequence of prices that have ballooned out of range for many real home buyers. And even investors that convert homes into rental properties have seen their business model get hit by high prices, and they’re pulling back.
But the Fed doesn’t want to see the issue of home prices bubbling out of reach. Chair Yellen emphasized in the Q&A following the May testimony that, as the report phrases it, “slowing housing activity was a major concern on par with geopolitical issues.”
For many central banks, double digit house price inflation would be a concern, particularly in European countries with a more ‘Germanic’ central bank culture. Yet the Fed seems on the whole unconcerned, in fact the opposite.
The report says in between the lines – UBS, which depends on the Fed, clearly can’t say this explicitly – that the Fed pretends to be blind. And it’s unique in its apparently wilful blindness: “No other major central bank has taken a similar line....” And so “the Fed will likely be in no hurry to shift towards a significantly more constructive tone,” at least not until the “dovish core around Yellen and Dudley change their tone.”
Alas, we’ve seen that the stuff Fed heads proffer in public is either a sign that they don’t have a clue, that they disagree, or that they say whatever they find useful at the moment in their relentless efforts to manipulate the markets and get investors and traders to buy, buy, buy. And what they discuss behind closed doors and what they actually end up doing are entirely different stories.
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