Submitted by Michael Every of Rabobank
Lower for loooonger
The institution known for being a staunch supporter of easy monetary policy has just realized that things are getting tricky.
As the IMF holds its annual meetings in Washington this week, Thomas Adrian, it’s Financial Counselor and Director of the Monetary and Capital Markets department, discussed the latest Global Financial Stability Report, carrying the ominous title “Lower for Longer.” Although the institution still believes that with low interest rates “[…] financial conditions have eased, helping contain downside risks and support global growth”, it is also increasingly concerned that such conditions have “encouraged investors to take more risks in a quest to achieve their return targets”, with “valuations stretched” in some important markets and economies. In particular the IMF sees growing vulnerabilities in the shadow banking sector (non-bank financials), which includes structured finance vehicles, asset managers and finance companies; with vulnerability levels having reached similar levels seen at the height of the global financial crisis. “The search for yield […] has led them to take on riskier and less-liquid securities. These exposures may act as amplifiers to shocks”, Mr. Adrian said. But corporate debt, with almost 40% being at risk of default in the eight economies the IMF studied, is also a growing headache.
Unsurprisingly, the response by policy makers should, according to the IMF, not be to get rid of the policies that have caused these excesses in the first place, but to introduce new “macro-prudential tools” to mitigates vulnerabilities. Surely this would take away some of the sharp edges related to the problems highlighted above. But at the same time would it allow other ‘invisible’ imbalances under the radar of policy makers to continue to build up. It’s like putting an obese patient on a high-carb diet but forcing him to take pills to suppress the side effects. The long-term consequences remain unknown.
The IMF also advocates greater multilateral cooperation in several areas, including global (regulatory) reform. We would argue that against the current backdrop of (geo)political tensions between the main global players, better coordination seems rather fanciful. What we do know, however, is that central banks are still leap-frogging each other in easing their policy settings. About 70% of the world’s economies, weighted by GDP, have eased monetary policy, according to the Institution. The rate cut by the central bank of South Korea was the latest in this series, taking the Korean official bank rate to 1.25%, back to the historical low we saw in 2016-2017. The KRW weakened slightly despite the widely anticipated move.
Meanwhile there is no Brexit deal, yet. But the EU and the UK are getting closer and closer to a compromise. It was reported yesterday that a number of thorny issues have now been resolved. Northern Ireland will follow EU rules on tariffs and quotas and align with many of its regulations. This will require a regulatory and customs border to be drawn in the Irish Sea, and no major customs checks on the Irish island. If the UK then closes new trade deals with other countries at a later point in time, Northern Irish businesses would be eligible for a rebate. This deal would allow PM Johnson to boast that the entire country has left the EU, even though it could be easily argued that Northern Ireland remains de facto in the EU regulatory sphere.
The matter of consent is another key question. A very complex decision-making system has been proposed. Four years after the end of the transition period, so probably in 2025, the Stormont Assembly would be able to give its consent to continuing this special arrangement for another four years. If it then (or in 2029, 2033) decides not to, a two-year notice period would be granted to allow alternative arrangements to be put in place. This creates the risk of a hard border in the future. But if the Stormont Assembly were then to collapse during that period, the default would be that the existing arrangement would continue to apply.
There has been speculation that Johnson could make a sudden move to seal the deal this morning, but it remains highly unclear whether the new compromise will draw sufficient support in the UK parliament. This morning, the DUP has raised a series of objections to the tentative agreement, saying that “as it stands”, it could not support what is being proposed on customs and consent. These are the two most crucial parts in the new deal and the DUP sees this as a risk of a NI-only backstop that never ends. There is also a lack of clarity on how to deal with VAT, something Mr. Barnier also indicated yesterday.
The DUP only have 10 seats in Westminster, but the marginal importance of these seats is enormous. The government already doesn’t have a majority in Parliament and some of the Tory ERG members won’t be willing to vote for a deal that does not have the explicit backing of the DUP. So the arithmetic looks very difficult, if not impossible, even when Johnson manages to get some Labour-Leavers and Tory rebels to back his deal, as some of them are still very desperate to “get Brexit done”.
Today or tomorrow the European Council may still agree on a legal text, but there is a huge risk that it will then again be rejected by the UK MP’s. If there is no deal by Saturday that can find a majority in Parliament, the UK Prime Minister must ask the EU for an extension of Brexit. Boris Johnson, however, has previously said that he would rather die in a ditch than to comply with the Benn Act and ask for an extension. Well, he better starts digging then?