The sheer volume of cross-border investment flows is threatening the independence and influence of central banks across the world. For Canadians who care about the value of the loonie, or the effects of interests rates on dividend and income stocks, the trend is of singular importance as the Bank of Canada tightens monetary policy.
Canada’s proximity to the United States makes the concept of cross-border asset flows familiar. In the current situation, for instance, a strengthening U.S. dollar as the U.S. Federal Reserve raises rates has combined with trade tariff fears to benefit American retail stocks, such as Target Corp., that generate the majority of their revenue from the United States.
As these retailer stocks rise, Canadian investors are more likely to buy U.S. equity mutual funds and exchange-traded funds, which represents a cross-border flow of assets from Canada to the United States. This is far from just a North American phenomenon. Loose monetary policy in China provides bids for Canadian real estate, and easy credit and a weakening yen in Japan results in their country’s investors allocating funds to U.S. technology stocks.
Citigroup’s Britain-based credit strategist Matt King was among the first analysts to grapple with the implications of increasing cross border asset flows. The exchange below was part of an extended e-mail interview (edited for brevity) I did with Mr. King earlier this summer.
SB: Investors in all markets including real estate tend to view rate and monetary policy on a national basis – Bank of Canada driving our housing prices higher, for example – but you were among the first to emphasize global central bank policy. The ease with which investors in Japan or China can invest in U.S. technology stocks, for instance, means that loose monetary policy in one major country quickly spreads to asset prices everywhere. Can you discuss where the major central banks are in this process?
MK: As with many other aspects of globalization, cross-border effects have grown so much in recent years that individual national authorities are often far less in control of their own destinies than it is comfortable for them to admit.
To take one trivial (if stunning) example I stumbled across: Australian house prices, and Sydney’s in particular, correlate far better with credit growth in China than they do with credit growth in Australia. How is the local central bank supposed to respond to that? If they raise interest rates when prices are booming, they risk pulling in still more foreign capital.
A few people, even in official circles, have acknowledged these linkages (in particular, there is a classic 2013 paper, The Global Financial Cycle and Monetary Policy Independence, by [London Business School professor of economics] Hélène Rey, which argues that it is now impossible to have both freely mobile capital and an independent national monetary policy).
In recent years there is strong evidence that asset prices have responded to global monetary policy rather than individual central banks’ policies, and to the change in their asset purchases rather than their absolute level. When the Fed began shrinking its balance sheet last year, the effect was offset by the continued purchases by the [European Central Bank] and [the Bank of Japan]. Now, though, they are all moving in the same direction at the same time – and lo and behold, risk assets are suddenly looking much more vulnerable than they were last year.
Some interview takeaways
Mr. King covered a lot of ground in his response. The connection between Chinese credit growth and Australian real estate prices will be familiar to Vancouverites who have seen Asian money distort their housing market.
His note on the Australian central bank dilemma – “If they raise interest rates when prices are booming, they risk pulling in still more foreign capital” – suggests that raising rates to cool the housing market might make matters worse. A rate increase would lift the value of the Australian dollar, which would make the country’s assets, including real estate, more attractive to foreign buyers. The Bank of Canada could potentially be confronted with the same issue.
Investors are accustomed to looking at central bank policy on a national basis. The Federal Reserve affects the S&P 500, the Bank of Japan’s influence is limited to the Nikkei and the Bank of Canada’s policy causes change in the S&P/TSX Composite Index. Mr. King, however, argues compellingly that it all has to be lumped in together because the total amount of major central bank stimulus affects markets all across the planet as investors reallocate capital across borders.
Perhaps most disquieting is the lack of study on the effects of mobile investment dollars and the thought that possibly, central banks no longer have as much control over their countries’ economies.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.
Monetary policy and risk assets:
A global view
Citi credit strategist Matt King points to the
correlation between the MSCI World Index
performance and total central bank asset
market purchases to highlight the aggregate
effects of stimulus on equity market returns.
Mr. King would not suggest that this chart tells
the entire story – there are too many other
factors affecting markets outside of central
banks. But the existing relationship does not
appear to be good news for future equity
returns in light of expectations for fewer central
bank market interventions.
Total global central bank purchases
in US$, billions (left)
Estimated CB purchases (left)
MSCI World Index three-month % change (right)
0.6%
$300
250
0.4
200
0.2
150
0.0
100
-
0.2
50
-
0.4
0
-
0.6
-50
2008
2010
2012
2014
2016
2018
THE GLOBE AND MAIL
SOURCE: scott barlow; Citigroup
Monetary policy and risk assets:
A global view
Citi credit strategist Matt King points to the correlation
between the MSCI World Index performance and total
central bank asset market purchases to highlight the
aggregate effects of stimulus on equity market returns.
Mr. King would not suggest that this chart tells the entire
story – there are too many other factors affecting mar-
kets outside of central banks. But the existing relation
ship does not appear to be good news for future equity
returns in light of expectations for fewer central bank
market interventions.
Total global central bank purchases
in US$, billions (left)
Estimated CB purchases (left)
MSCI World Index three-month % change (right)
$300
0.6%
250
0.4
200
0.2
150
0.0
100
-
0.2
50
-
0.4
0
-50
-
0.6
2008
2010
2012
2014
2016
2018
THE GLOBE AND MAIL, SOURCE: scott barlow; Citigroup
Monetary policy and risk assets: A global view
Citi credit strategist Matt King points to the correlation between the MSCI World Index
performance and total central bank asset market purchases to highlight the aggregate
effects of stimulus on equity market returns. Mr. King would not suggest that this chart
tells the entire story – there are too many other factors affecting markets outside of
central banks. But the existing relationship does not appear to be good news for future
equity returns in light of expectations for fewer central bank market interventions.
$300
0.6%
Total global central bank purchases
in US$, billions (left)
Estimated CB purchases (left)
250
0.4
MSCI World Index three-month
% change (right)
200
0.2
150
0.0
100
-
0.2
50
-
0.4
0
-50
-
0.6
2008
2010
2012
2014
2016
2018
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: scott barlow; Citigroup
Scott Barlow