The Economist 20161001 ed79b8

The Economist October 1st 2016 Finance and economics 69
2 was modest, limiting production to
32.5m-33m barrels per day, which is between
0.7% and 2.2% below current output.
Saudi Arabia’s production was likely to fall
anyway as the winter approaches. The
agreement was also vague. Members will
wait until their formal meeting in November
to settle how the overall cut will be distributed
amongthem. Nonetheless, within
hours of the report, the price of oil rose by
over 5% (before easing somewhat). To the
question doesOPEC still matter, the market
had given its own emphatic answer.
Even OPEC-doubters will take note of
what the agreement says about Saudi Arabia.
The kingdom had insisted that it
would cut output only if other producers
followed suit. This insistence that OPEC cut
as one or not at all brought it into direct
conflict with other members like Iran.
After EU sanctions were lifted earlier this
year, Iran has been set on ramping its oil
production as fast as possible. The Algiers
agreement became possible only because
Iran seems to have won this argument. It
would be allowed to produce “at maximum
levels that make sense”, said Saudi
Arabia’s energy minister—a softer Saudi attitude
that may reflect harder constraints at
home. Low oil prices left the kingdom with
a budget deficit of15% ofGDP last year.
But will the agreement work? It has already
moved the oil price. But then, one
might argue, what doesn’t? The oil markets
have been unusually volatile this year, as
they struggle to find theirbearings in a new
landscape, marked by slower global
growth, resilient shale producers and the
return of Iran. Amid great uncertainty
about these changed fundamentals, commodity
traders can lapse into secondguessing
each other. Even if every trader
suspects that OPEC in fact no longer does
matter, OPEC will remain powerful until
everyone knows everyone else agrees. 7
Buttonwood
Taking it to 11
How central banks are distorting the corporate-bond and equity markets
IN THE spoof “rockumentary”, “This is
Spinal Tap”, Nigel Tufnel, the band’s guitarist,
displays his amplifiers with pride. Nikkei 225 performance relative to Topix
Heavyweight effect
The dials range not from one to ten, but up
January 1st 2016=100
to 11. On a normal amp, he explains, when
you reach ten, there is nowhere to go, but
“these go to 11.”
Three of the world’s most important
central banks—the Bank of England, Bank
of Japan (BoJ) and the European Central
Bank (ECB)—have dialled monetary policy
up to 11, expanding their asset purchases
from government bonds to embrace
corporate debt and even equities.
With government bonds and short-term Source: Thomson
Reuters
interest rates already at historically low
(and in some instances, negative) levels,
such asset purchases were seen as the
next logical step.
The expanded policy has several justifications.
It is not clear that driving government-bond
yields or short-term interest
rates any lower will do a lot to help the
economy; negative rates may dent bank
profits, for example, making them more
reluctant to lend. And if the aim is to get
companies to borrow more, then buying
their bonds will reduce the cost of that
borrowing via lower yields.
But there are many more types of private-sector
assets than there are government
bonds. (The ECB’s government
bond-purchase programme is linked to
the size of each euro-zone economy, so it
cannot be accused of favouring one nation
over another.) Central banks simply
cannot buy all corporate bonds or equities
in equal measure.
Naturally, they choose the most liquid
and the least risky. But the bonds and equities
they buy are likely to perform better
than others. Since the ECB announced its
bond-buying programme on March 10th,
the spread (orexcessinterestrate overgovernment
bonds) on corporate bonds that
POLICY CHANGE*
Jan Feb Mar Apr May Jun Jul Aug Sep
2016
104
103
102
101
100
*Bank of Japan buying shifts to
a higher weighting in Topix
it deems eligible has fallen by over half,
from 100 basis points (one-hundredths of a
percentage point) to 44 basis points, reckons
Citigroup. The spread on ineligible
bonds has also fallen but by only a third,
from 154 to 104 basis points.
When companies seek to issue new
bonds, the prices and yields of their existing
bonds are an important benchmark. To
the extent that central-bank actions lower
the cost of capital of businesses within the
programme, it must give them a competitive
advantage over their rivals. The Bank
of England, for example, is buying bonds
issued by Walmart (which owns the Asda
chain in Britain) but not bonds issued by
Tesco or Morrisons, two rival supermarkets.
The effect may be small, but it is still a
questionable thing for a central bank to do.
Moreover, the British corporate-bond
market is not as deep as the American
equivalent so the Bank of England is limited
in the bonds it can buy. This leads to
some odd-looking inclusions. Will the purchase
of sterling bonds issued by Apple,
Daimler or PepsiCo really lower the cost of
capital for British finance?
Investors will adjust their behaviour to
99
98
allow for the actions of central banks. “It
almost feels as if our role shifts from analysing
the bonds’ fundamentals to advising
clients on the eligibility criteria,” says
Matt King, a bond strategist at Citigroup.
The BoJ has already been forced to adjust
its equity-buying programme after it
seemed to distort the market. The bank
might have thought it was playing safe by
purchasing an equity index. But a lot ofits
money was going into the Nikkei-225 average,
a benchmark weighted by share
price rather than market value (see chart).
So its investments were having a disproportionate
effect on the share prices of
some small companies. In the case of Fast
Retailing, the BoJ already owns halfofthe
free float (the shares available to outside
investors). Future purchases will be
weighted to the more sensibly constructed
Topix index.
Anotherissue is how the central banks
will eventually dispose of their holdings.
Although, when theystarted in 2009, government-bond
purchase schemes were
seen as short-term measures, central
banks have yet to reduce their bond piles.
The Federal Reserve is slowly tightening
monetary policy by pushing up shortterm
interest rates, not by selling bonds.
Corporate bonds are less liquid than
government bonds, particularly since
post-crisis rules have made banks less
willing to hold inventories. A likely consequence
of this is that central banks will
be big owners of private-sector assets for
a while, with all the distortions that implies.
They will not want to risk a big
shock by selling billions of bonds into an
illiquid market. If that day comes, traders
might be quoting Mr Tufnel again: “How
much more black could this be? And the
answer is none. None more black.”
Economist.com/blogs/buttonwood