Managing Liquidity in Today’s Low Rate Environment
by Kathleen Hughes, Head of Global Liquidity Management Sales, and Jason Granet, Head of International Liquidity Portfolio Management for Global Liquidity Management, Goldman Sachs Asset Management
Economic growth appears to have slowed significantly in many parts of the world. What is your outlook for growth over the next 12 months?
We’ve seen ebbs and flows in economic growth since the financial crisis in 2008, but we have yet to see any sustainable run of growth that would set us up for what we could call a typical recovery. In a typical recovery, the economy is going to grow above trend for a period of time and start to reduce the output gap.
In this recovery, every time the economy has started to turn higher, we’ve hit setbacks. In 2010, the first round of the European sovereign crisis contributed to a slowdown that wasn’t technically a double dip, but certainly looked like one in terms of the shape. Growth picked up pace again with the Fed’s second round of quantitative easing, but has slowed once again and markets have been extremely volatile. Events have also contributed to investor concerns about growth. These include the recent debt ceiling debate and rating downgrade in the US, and the spread of volatility in European sovereign debt to countries like Italy and France. Considering this backdrop, we don’t think it’s clear yet what would be the impetus for a reacceleration in growth, and so we think the risk of recession in the US may have increased significantly. In our view, modest economic growth is now probably the best-case scenario.
The European story is also concerning but somewhat different because of the different levels of economic growth among the countries in the Eurozone. Germany has clearly generated some very strong growth and unemployment has fallen to record levels. However, the economic situation in some of the so-called ’peripheral’ countries like Greece, Ireland, Spain, Italy and Portugal has deteriorated over the last two years, raising global concerns about the European banking system. The situation in many of the peripherals and the broader global slowdown appear to be weighing on growth in Germany; the economy grew just 0.1% in the second quarter versus 1.3% in the first quarter. We don’t expect a recession in Germany but we do think growth will be slower and the risks are probably to the downside. The UK is somewhere in the middle between the US and Europe. Europe has a significant influence on UK growth, and so does the US.
How do central bank policy responses compare across the US and Europe?
We think it’s interesting the way each central bank has handled its own situation. European Central Bank (ECB) policymaking seems to have evolved very differently compared to the policies in the US and UK, and part of the reason is that the ECB’s task has been greatly complicated by the economic disparities across the Eurozone. Because of these disparities, the ECB seems to have chosen to target its interest rate policy towards countries with stronger economic growth while taking other measures to support countries with weaker growth. For example, the ECB is offering European banks unlimited funding on a secured basis. Providing unlimited liquidity is an unconventional policy, and the ECB has made this policy even more unconventional by pairing this liquidity provision with interest rate hikes. Their approach contrasts with the US, where the Federal Reserve (Fed) has provided liquidity through quantitative easing measures as part of an overall easing programme.
We have always believed in a tiered approach to liquidity.
Throughout this cycle, the Fed has handled monetary policy by the so called ’crisis playbook’, which says that you should lower interest rates until you can’t ease any more and then you should do quantitative easing and anything else you can do to make financial conditions easier in a crisis.
The Bank of England (BoE) seems to have handled their policy by a similar playbook. But like the ECB, the BoE has a single mandate to target inflation, so it’s striking that the BOE has decided not to raise rates even though inflation has been persistently above target. Traditionally inflation has been seen as an all-encompassing indicator for monetary policy, based on the idea that inflation is a representation of all broad macroeconomic conditions. But, in our view, the world has changed and just because inflation is elevated that doesn’t mean that macroeconomic conditions warrant a tightening of monetary policy. We think the BoE recognises this and has been able to effectively decouple the relationship between inflation and monetary policy, whereas the ECB has been less willing to adjust its approach. The Fed reached the same conclusion as the BoE, but its stance was easier to defend, because it has a dual mandate covering inflation and employment.