We’re in uncharted territory.
As the Fed begins to shrink its balance sheet and put an end to so-called quantitative easing — the policy move credited with helping the United States rebound from the financial crisis — investors are nervous a mistake could upend markets.
“One of the things that always keeps up at night is the risk of a policy mistake,” Mike Ryan, CIO of UBS Wealth Management Americas, told Business Insider in a recent interview.
Ryan emphasised uncertainty surrounding central banks’ next moves, in light of the unprecedented nature of the crisis and the response to it.
“I tell people: ‘Look, every time I checked, every one of the central banks all around the world, the pencils come with erasers at the top.’ There’s no infallibility. Vatican City’s the only place that claims infallibility. Central bankers do not have that, nor do they claim it. We have to also understand we’re living through what has been the greatest monetary-policy experiment in history. We’ve never seen this before.”
In the aftermath of the great recession, the Federal Reserve bought up $US4.5 trillion worth of Treasury bonds and mortgage-backed securities in order to keep borrowing costs cheap. Now that the economy is back on its feet, the central bank plans to let these bonds roll off its balance sheet once they mature.
Ryan pointed out that unconventional moves like bond purchases and negative rates have challenged investors’ common wisdom. “I grew up in an environment where, early in my career as a fixed-income strategist, I was led to believe that zero-interest rates were a lower bound,” said Ryan. “Well, that’s been put on its head because rates can go below zero. So we’ve had a change in the rates dynamic, but we’ve also seen a much different approach in terms of how central banks are willing to expend and expand their balance sheets.”
So how can the Fed avoid making mistakes that would scare investors and possibly cause a downturn in the record-breaking bull market? By working slowly and transparently, Ryan says.
“There is no rulebook, there’s no guidepost to how we do this,” said Ryan. “I think what it’s going to require is very prudent actions by central bankers; they’re going to have to be cautious in terms of how they apply policy changes. They’re going to have to be very open and transparent with markets about what they intend to do and what they are doing.”