Once you hit rock bottom, it was once said, you can only go up. Once you hit rock bottom, they say today, you start digging. Zero has been, since the dawn of civilization, the absolute minimum for interest rates. Sovereigns, whether crowned heads or central banks, have penalized creditors with inflation, debt restructuring or default, but nominal rates have not even crossed zero in Japan. Switzerland in the past or Denmark since 2012 are technically justified exceptions, not policy decisions with deep symbolic meaning. Life for central bankers has been difficult these years. Digging under the floor is more tiring than going down surrounded by air or water. Digging is also intellectually stressful, because it means suspending the economic laws under which many were raised and declaring a state of exception.
Difficult, therefore, but you get used to everything. Once one taboo is broken, it's easier to break another. Venturing into a new world is less challenging the further you go. At a certain point, if the world remains standing, we move forward with fewer doubts, more quickly. In the end, you also get a taste for it and you can even become reckless. There was a time, even if we've almost forgotten it, when, after the worst moment of a crisis, central banks waited just a couple of quarters to start normalizing their policies by raising rates. After the 2001 recession, Greenspan's Fed was seen as aggressive and waited until the spring of 2003, also because of the Gulf War, to start a long cycle of rate hikes. Little was expected, therefore, and once the normalization started, we proceeded quickly. Today, on the other hand, after five years of global recovery and with stock exchanges like New York tripling in value, Quantitative easing, initially endemic, has become an almost universal rule and the exception is its suspension, not its validity.
Of course, it can be argued that the Fed is in the process of tapering, progressively turning off Qe and that next year it will start raising rates. True, but the reduction in borrowing requirements by the US Treasury is even greater than the reduction in purchases of securities by the Fed. As for rates, our wager is that the majority component of the Fed is certainly willing to raise them but, and herein lies the decisive point, less than inflation will increase. As for the ECB, beyond the measures decided today, unanimously considered in the high part of expectations, it is a small sentence from Draghi's press conference that tells us, more than anything else, how the mental structure is changing in Europe and, in particular, in Germany. When asked about the reasons behind the end of the sterilization of the Securities Markets Program liquidity injections, Draghi replied with great candor that inflation is too low. Net of technicalities, it's like asking a faithful why he killed the sacred cow and being told that he was hungry. It is a simple and practical answer, but also a stab at the theological heart of German ideology. With these premises Qe becomes possible and even probable, it will only be a matter of politically evaluating its timing and methods. The leading central bank, the Fed, is moreover making it clear in every possible way that it will continue to look for any excuse to remain expansive and, if possible, become even more so. The boundaries for changing policy are being pushed forward all the time. Once one goal is achieved, another is invented. Previously we had to bring down the number of unemployed, then raise the participation rate in the labor market, now we want wages to grow, tomorrow we will target nominal GDP.
The effect of this changed attitude is very positive for stock markets, at least in the short to medium term. For bonds, however, things get more complicated. In a traditional positive business cycle, bonds fall in price twice, once because nominal rates rise, once because real rates rise. This time it is possible that nominal rates will rise and real rates will fall at the same time, becoming negative. The impoverishment, for bondholders, will be less perceptible, but it will still exist and it won't necessarily be modest. It won't be very visible when you look at the quarterly statement, because bond prices will fall little, but it will be when you try to shop at the supermarket paying in bonds. There is however a problem. Central bankers are increasingly mentally flexible, but the balance sheet of the central banks they manage is increasingly large (not the case of the ECB, which with today's measures restores, not even completely, the level of its 2010 assets). The risk of sudden inflation at some point in the future remains. This risk could initially be welcomed by policy-makers (it would eliminate a portion of the public debt in countries like ours) but it would soon become difficult to manage without sharply raising rates. Everything will be easy, even for those who invest, for this and perhaps next year. Then it will get progressively more difficult. Bonds will produce negative real returns, stock exchanges will produce high volatility.
Even the economic cycle, from a certain point forward, will become more irregular and there will be consequences if some maneuver is made wrong. The euro will be weaker in the coming months, but not by much. The markets, and behind them America, will continue to press for a full-blown European Qe. Only then will they really accept a euro at 1.30. The stock exchanges started the sell-off phase on the news with the idea that until the end of the year we won't have any more surprises in Europe. Those who had bought waiting for Draghi can now sell something. Those who haven't done so will do well to take advantage of any phases of weakness, with the caveat that, if they do come, they won't be long or deep.
