The DVFA Investment Professionals expressed their current assessments of monetary policy in the latest DVFA monthly survey. The background to this was the markets’ clear expectations of “expansion” over the course of the year, which are already anticipating multiple and significant interest rate cuts by the Fed and ECB.
Ingo R. Mainert, Deputy Chairman of the DVFA Executive Board, explains: “The main objective of the Fed and the ECB is still to restore the desired price level stability. Around three quarters of our survey participants consider the Fed’s steps to date to be sufficiently restrictive. Only 58% think the same of the ECB’s monetary policy. Conversely, one in three of those surveyed consider the ECB to be insufficiently restrictive, while only one in six think the Fed is. Overall, the Fed’s policy is therefore rated as more robust and less hesitant than that of the ECB. And the respondents’ expectations regarding the timing are clear: 86% say that the Fed will start cutting interest rates in 2024 and the ECB will follow in its wake.”
Key interest rates: forecasts for the Fed and ECB at the end of 2024
The last few years have clearly shown how difficult it is to forecast interest rates in times of heightened geopolitical and economic risks. Nevertheless, macroeconomic forecasts are important decision-making aids for institutional market participants, savers, borrowers and, not least, politicians. When asked about their key interest rate expectations for the end of 2024, 42% believe it is most likely that the Fed will lower the key interest rate ceiling by at least 100 basis points by then. Only 15% expect this for the ECB, while 70% see the ECB deposit rate at the end of the year at between 3.25% and 3.75%.
Where do you think key interest rates will be at the end of 2024?
EWU =European Monetary Union
Central banks' balance sheet totals: will shrinkage soon counteract the interest rate reduction policy?
Following the massive bond purchases by the two major central banks (quantitative easing, QE), they are faced with the question of how quickly and in what way they should or can reduce their balance sheets again. This is because QE was also used to artificially lower capital market interest rates for a long time. If the central banks now not only no longer replace maturing bonds in their portfolios, but also actively return holdings to the markets (quantitative tightening, QT), the resulting liquidity shortage would potentially hinder the expected interest rate reduction policy. Nevertheless, almost two in three respondents (63%) expect the balance sheets of the Fed and ECB to continue to shrink. By contrast, one in ten do not expect this, with 27% undecided.
Separation of interest rate cuts and liquidity tightening: sensible, at least in the short term
Despite the outlined risk of inconsistent monetary policy, 31% of participants consider a separation of interest rate cuts and liquidity tightening (QT) to be sensible and efficient, while 26% are against it. For 17%, this is necessary at least in the short term. However, more than one in four think it is still too early to make an assessment.
Impending central bank losses: technically not a problem, but a threat to reputation
As a result of the bond purchases and the sharp rise in key interest rates, some central banks are now facing years of increased interest expenses as well as lower profits or even losses, which could lead to a release of reserves and an erosion of equity (see box). However, 71% of the investment professionals surveyed do not see a problem for the capital markets even if the central bank has a negative equity account.
Background: As the members of the Eurosystem (ESCB) have decided to account for the majority of their bond holdings at amortized cost rather than at market value, the national central banks and the ECB are initially hardly threatened by valuation-related write-down losses. They would only have to realize such losses if and to the extent that they channel bonds back into the markets through effective sales (QT). However, they are now threatened with losses. This is because banks procured or sold the bonds to the central banks on the secondary market in order to carry out QE and in return received central bank money credited to their central bank accounts by the central bank. This money is now predominantly held in the deposit facility and earns interest from the central banks in the eurozone at the deposit rate, which is now 4%. This interest expense is a burden on the Bundesbank’s income statement. Even if the Bundesbank receives higher interest income from the German target balance at the same time, it will probably not transfer any profits to the Federal Minister of Finance in the coming years.
Ingo R. Mainert states: “Should the central banks incur losses that exceed their reserves or equity as a result of the enormous bond purchases and the resulting interest expenses, they will still be able to operate sustainably. Only if losses persist and their main objective of price stability is missed several times could a reputation and trust problem arise for the monetary authorities – as we know, trust comes on foot and goes on horseback.”
The DVFA monthly question is addressed to the association’s 1,400 members and is dedicated to topics that are being discussed in the financial sector. The results of the survey are published regularly on the 2nd Tuesday of every month.
Source: DVFA Monthly Question from February 12
This is an automated translation of the German original.
