Thu, 18 Apr 2013
Monetary policies in the U.S., Europe, Japan, and elsewhere carry long-term uncertainty and potential unintended consequences for fixed-income investors, says Western Asset's Steve Walsh.
Jeremy Glaser: I want to ask you a little about Japan. They're now going to double their monetary base during the next two years. Is this a plan that you think can work to kind of pull Japan out of its deflationary spiral, and do you think it could serve a model and we could see even more monetary stimulus from the Fed, from the European Central Bank, or from other developed nations?
Steve Walsh: Yeah. A good question and similar to the question you asked me about, whether the Fed will be able to gracefully back off this. I've talked a lot about the issue and said we favor a little bit more of a bumpy road, but didn't draw any huge conclusion, which I think is difficult for anybody to have a lot of conviction in their ability to discern whether the Fed is going to be able to be effective or not. I think it's similar with the Bank of Japan. This, again, is extraordinarily unprecedented.
I would twist the way you said something though: "Will other central banks follow Japan?" What Japan is basically doing now is following other central banks. I said the big change in Europe last year was the change in philosophy at the ECB, as they decided to use a lot more tools in the tool shed similar to how the Fed has approached this issue over the course of the last few years.
Japan is now, I think, ramping up the size meaningfully more than what's going on in the U.S., but the tools are similar to what the Federal Reserve has done. So, they are just saying, "Hey, I'm going to use the same medicine you used. I'm just going to use a lot more of it."
Is it going to work? Gosh, Jeremy, again, you'd like to think the chief investment officer of Western has got that answer down pat, and I challenge any CIO who says they know exactly this is going to work or this isn't going to work. Again, I think we're a little skeptical over the longer term that this policy is going to be successful. If I said that what's going on around the world is an extraordinary monetary experiment, what Japan is doing is beyond an extraordinary monetary experiment in terms of the size relative to their GDP, and what they are going to do with their balance sheet and the political support for it and almost the linking together the political and the monetary policy decision here, which arguably is not necessarily what an investor wants to see. They'd like to see that sort of independence.
I think the thing with Japan that you need to pay attention to is kind of like whether this time is different. They've had these sort of pretty strong programs in the past. Remember, they've been doing this since the early 1990s; they've been in the soup since the early '90s. They tend to get cold feet and back away from the programs, and that's been some of their challenge in the past. So I think a key thing for investors to watch and ask the question you don't know is will they stick with this program. I believe there's a greater likelihood that they will stick with this. Prime minister Shinzo Abe seems to really believe in this and has made his whole platform sort of "We're going to encourage and support the Bank of Japan's efforts to really dial up monetary policy here."
So, will it work, can they will inflation higher, can they get it higher? Again, I wish you knew the answer to that. Again, it's the reverse of "Will the Fed be able to back away?" These are real questions. They are experiments in a model-based vacuum and a chalkboard in a classroom. They can work pretty well, and that's why they're designed this way in a global financial market. Is it quite as easy? No. Could there be unintended consequences? Absolutely.
So, again, I think with all of these central bank activities, whether it's what the Fed is doing, what the ECB has done and probably will continue to do, and now what the Bank of Japan is doing, there are really two risks, kind of, broadly speaking, that there are unintended consequences. These are a lot tougher to back away from, and you know what, it's a lot bumpier of a road when and if they ever have to back away from these. But the other risk is that investors over time find out that all this policy is impotent. It actually doesn't have the effect it's supposed to have. I mean, if Japan is going to double the size of their balance sheet and their monetary base and they can't get inflation, my goodness, that's a risk, too. They have done all this and it doesn't accomplish the goal. And then investors start to say, "Wait a minute, monetary policy doesn't work. It can't help the U.S. growth or can't help Japanese growth or inflation." And that again poses another set of risks.
So having been in the business 30 years, I think the extraordinary thing about today is how much of our conversation. Can you imagine, Jeremy, me and you having a conversation in 1997 or '94 or 2003 or '86? I mean, there has always been some policy and you've always had central banks, but we've never ever had such massive policy intrusion being thrust upon markets. Intrusion is not necessarily a great word because that sounds like it's all bad. But it is a great monetary experiment, and experiments again can work and they can't work, but we don't have a lot of precedents, which I think makes it difficult to kind of work through the calculus as an investor. Am I paid to take risk here? At Western, we've generally felt, you know what, still stay with the risk asset sectors within fixed income, but you ought to have less today than you had eight months ago, and kind of start to dial it back at little bit is the way we've approached it, given the very, very strong performance and the tighter spreads that have come over the course of the last eight months.
Glaser: Steve we really appreciate your insight today.
Walsh: Thank you very much, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.