In this Q&A, Andrew Belshaw, Head of Investment Management, London, discusses the short-term and long-term impacts that Brexit, the UK’s decision to leave the EU, will have on the UK, the eurozone and global financial...
Although, the estimates are very imprecise and range from 0.3 to 0.7, depending on the specification and sample size, the thrust our results suggests that the short term pass-through elasticity is less than 0.3 and the long run elasticity is less than 0.6.
In the case of foreign currency loans, there is no statistical evidence for the existence of a bank lending channel which may be related to the prevalence of long-term loans in total foreign currency loans and relatively short sample size.
Encouragingly, this time around markets don’t appear to be making the same mistake. In the US the market pricing of the path of short-term interest rates has actually moved lower this year, even as the change to reinvestment policy has moved closer. And in Europe recent communications about a potential taper of asset purchases has had limited impact, if any, on the pricing of the short-term rate path. This is a key difference from 2013; this time around, central banks have been more successful in maintaining expectations that broad accommodation will remain in place—and should that hold, it will be an important departure from the taper tantrum.
So, a number of years later we are now in the position to answer the following question. Which matters more in the current environment: the Fed adjusting its balance sheet policies or the path of growth and inflation? The obvious answer is that the path of growth and inflation are much more important. Yields on 10-year USTs are lower today than they were at the peak of the taper tantrum, even though over the intervening years the Fed has not only adjusted its balance sheet policies but also hiked rates four times. Even if an adjustment of central bank balance sheet policies leads to some turbulence, over the longer term the fundamentals will likely reassert themselves and bond yields will reflect growth and inflation.
Yet, market participants struggled to make the distinction between changes in asset purchases and the broader accommodative stance. In the immediate aftermath of Bernanke’s comments, the market repriced its expectation for the future path of short-term interest rates from one hike to four full hikes by mid-2015 (Exhibit 1). And this repricing was in spite of the fact that Fed officials were pushing back very hard and reasserting the forward guidance at every opportunity. For example, in July 2013, New York Federal Reserve President Bill Dudley said that “a rise in short-term rates is very likely to be a long way off.” We think it’s hard for a Fed official to be more direct than that. (This ended up being more accurate than perhaps Dudley intended, as a first Fed hike didn’t come until December 2015, partly due to the large fall in oil prices in 2014.)