Morgan Stanley, traditionally the second most Kool-aidy bank on Wall Street, just after Deutsche Bank (and specifically the Germans' head economist) begins its latest report on the challenges facing the "global central bank" on a rather downbeat note: "Slowing growth is threatening the creditless, jobless recovery in the US and the Fed stands ready to act. The European flu has flared up and the risks to the ECB’s strategy of normalising policy have risen markedly. And emerging market central banks are balancing domestic growth against downside risks to developed market economies as they keep policy from becoming restrictive or even tightening too quickly. The world today appears to be in an eerily similar place to mid-2010." Hmm, where have we heard this 2011=2010 theme before... Anyway, it gets worse: "there are some important differences too. This time, the US and euro area economies are facing downside risks to growth just as normalising monetary policy is slowing EM economies down too. A year ago, EM monetary policy was still stimulative and domestic demand growth was encouraged as output gaps were still negative. The risks to global growth today are thus broader now than they were last year. At the same time, the thresholds for central banks to ease appear to be higher this year too. Rising core inflation in the US, elevated inflation in the euro area and a recent battle with inflation in the EM world all make it difficult for central banks to abruptly reverse the direction of policy. A look at the challenges facing DM and EM central banks has the Fed, the ECB and the RBA facing the biggest downside risks to growth in the DM world while the ECB (again), the BoE and the Riksbank face immediate inflation concerns. In the EM world, central bankers have no time to rest despite a recent victorious battle with that old enemy, inflation. European contagion and weaker global growth should keep policy-makers there on their toes for the next few months." Indeed it should, but with so many central bank actors, each of which experiencing their own set of unique challenges, who can keep track of all the often times opposing responses that the central planners are presented with? Well, courtesy of this handy, dandy tearsheet from MS, now you can too.
What does all this mean. For what it's worth here is Morgan Stanley's base case:
While the discussion has centred on the materially higher risks and the scope for policy mistakes, we maintain our base case of a better 2H performance in the US and a policy-led containment of euro area problems (though not a comprehensive solution to these problems). The EM giants, China and India, were expected even before the onset of these higher risks to return policy from their slightly restrictive stance towards a more neutral one as confidence about inflation receding grows. Other EM economies are either close to the end of their normalising cycle or are likely to postpone it to early next year. Should our base case work out without the need for outright policy easing from the major EM and DM central banks, the direction of the next rate move from not just DM but also EM central banks could well be higher.
Naturally since this is Morgan Stanley the one guarantee is that the base case will not occur, which means that further easing is guaranteed. Naturally, even Morgan Stanley recognizes its horrendous predictive track record and thus adds a risk factors section:
[T]he risks surrounding our base case may prompt one or more of these to occur, probably starting with renewed purchases of assets by the ECB to augment the stop-gap measures we expect euro area policy-makers to administer – though things would have to deteriorate dramatically for the ECB to carry out renewed purchases. These risks are already raising the risk of contagion outside the euro area to CEEMEA economies. Should the downside risks to US growth materialise, further easing from the Fed and another round of policy accommodation from EM central banks would be reasonable to expect
And the conclusion:
Finally, it is worth emphasising that the ‘global central bank’ still has ammunition left, if needed. The Fed and the Bank of England could do another round of QE, the ECB could lower rates and purchase (more) bonds, and EM monetary authorities have room to cut policy rates: hardly an empty arsenal.
And let's not forget Japan, which yesterday Christine Lagarde's IMF realized that Japan is way overdue for more monetizations and easing:
The International Monetary Fund signaled that the Bank of Japan should buy more assets to combat falling prices as it forecast stronger deflationary pressure than the central bank.
"To ward off deflation risks and support the recovery, the Bank of Japan could increase purchases of longer-dated public securities and expand its asset purchase program for private assets," the IMF said in a statement yesterday in Washington.
The recommendations may put more pressure on the BOJ to consider further monetary easing by increasing its asset purchase fund, which it doubled to 10 trillion yen ($126 billion) after a record earthquake and tsunami in March. A Bloomberg survey of 14 economists last month showed that all but one expect the BOJ's next move would be to provide more stimulus and four expect the BOJ to expand the asset fund around August.
Of course, this helpful reminder to the BOJ is precisely what will end up happening. Which also means that the forecast for Japanese total debt to hit one quadrillion (Yen) needs to be brought up quite a bit. And when Japan start QEasing again, it will be the green light for all other central banks to follow suit. And so on, and so on, until China one day says enough and fully unpegs the CNY, making it fully convertible and in essence ending the dollar's reserve "tradition."