How many central banks will turn into hedge funds?

One of the under appreciated consequences of all the monetary easing and intervention that has gone on in the world since the credit crunch is the impact on central banks themselves. What I mean is that they find themselves holding ever larger sums of assets which in many cases they are compounding by often holding ever riskier ones. They are taking advantage of the fact that they are backed by national treasuries – although being backed by 19 national treasuries as the European Central Bank or ECB  has a different perspective in my opinion  – allowing the view that this is somehow risk-free to proliferate. Well it may not be risk-free for the taxpayers who find themselves backing all this!

The Bank of England

So far it has mostly confined itself to what we might call bog standard QE where it purchases UK Gilts. However it has been lengthening the maturity of its £375 billion of holdings in an Operation Twist style and now for example has some £989 million of our 2068 Gilt. Too Infinity! And Beyond! Indeed…

The main risk to taxpayers is in fact even less understood operations like the house price boosting Funding for Lending Scheme. Some £69 billion of cheap loans to banks have been issue here and should house price ever fall there are risks.

Foreign Exchange Reserves

These seem to be safe but the QE era has led to changes here because you see conventional theory has central banks investing in shorter dated bonds. Some of you will be spotting the problem already! This is how the Financial Times puts it.

European and Japanese (interest) rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

In other words investing at negative yields carries a guaranteed loss if you hold to maturity which is awkward to say the least when you come to explain your stewardship to auditors and indeed taxpayers. The ECB in particular is hoist by its own petard here as I recall it arguing that value on maturity was the way of valuing Greek bonds back in the day and of course that is still convenient there. But not elsewhere. We have just excluded the Euro and the Yen which of course are major markets (even now some 20% and 4% of reserve assets respectively) and logical ones to put some of your reserves. So what are they doing? From the FT.

central bank reserve managers are making or “seriously considering” buying bundles of loans repackaged as asset-backed securities or switching out of currencies affected by negative rates.

There are issues here as we move from theoretically at least safe government bonds to what are less safe assets. There are in fact two issues which the FT does not point out so let me point them out.

The good news for central banks is that a consequence of their own actions is that they have made a profit. Of course they will not put it like that! No doubt the press communiques will concentrate on skilled management and their own abilities. But the QE era has driven the prices of the bonds they hold as foreign exchange reserves higher and hence bingo. Even the own-goal by former UK Chancellor Gordon Brown when he sold gold at what is now cruelly called Brown’s Bottom will look a little better as the replacement strategy of buying bonds does well.

The catch is for future investment as what do you do now with bond prices so high? Indeed these “independent” central bankers will be under pressure from politicians who have no doubt got used to spending the profits created for national treasuries to carry on regardless as the film put it. But where do they go now to do this? The FT gives us a nod and a wink.

But central banks have shed some of their conservatism in recent years, with monetary policies such as quantitative easing forcing them to sell bonds and buy riskier instruments such as equities.

Revealing language there via “forcing them”. Really? Many central banks are not allowed to buy equities for this purpose and so they will be buying longer-dated bonds and dipping into riskier ones. I will discuss the equity buyers in a moment but here is an idea of scale for you.

Total managed reserves were $10.9tn at the end of last year, according to the International Monetary Fund.

Even in these times of ever larger numbers that is quite a lot. By the way how do the numbers keep getting larger when we are supposed to be in deflation? Anyway the UK government has net US $ 38.4 billion which the Bank of England manages. Tucked away here is the issue that gross reserves are around US $97 billion larger as we mull we have liabilities too and the phrase what could go wrong? The bit we do know is that if it should it will not be anybody’s fault.

Riskier bonds

Moving onto a slightly different field which is QE then the ECB gave us an example of this in yesterday’s update.

Asset-backed securities cumulatively purchased and settled as at 15/04/2016 €19,220 mln……..Covered bonds cumulatively purchased and settled as at 15/04/2016 €169,255 mln.

The ABS securities are the riskiest and as an aside you may wonder Mario Draghi made such a big deal of them as in the scheme of things purchases have been relatively small. The US Federal Reserve has been a big buyer in this area and as it still hold some US $1.76 trillion does not seem to have been keen on realising the value stored there.

Equities and property

Here we find what I labelled the “currency twins” back in the day as there were many similarities between the Swiss Franc and the Japanese Yen. The carry trade pushed their currencies lower originally but reversing it post credit crunch saw them shoot higher which the respective central banks resisted. Here are the consequences.

Swiss National Bank

This has the equivalent of some US $600 billion to invest as a result of its past interventions and promises to take on all-comers. Of that some 18% was invested in equities at the end of 2015 and that is why I refer from time to time to it being affected by movements in the share price of Apple for example.

The equity portfolios in the foreign currency investments were comprised of shares from mid-cap and large-cap companies (excluding banks) in advanced economies and, to a lesser extent, shares of small-cap companies. The SNB does not engage in equity selection; it only invests passively.

I wonder what Swiss watchmakers think of their central bank using their money to invest in the creator and manufacturer of the Apple watch? But as we observe this I note that of course we do have what might be considered purist hedge fund behaviour here which is punting, excuse me invested in Apple shares. The equity component had also risen from 15% to 18%.

Bank of Japan

The Bank of Japan also has large foreign exchange reserves amounting to some US $1.26 trillion. All that intervention had to go somewhere or to put it another way we see why the Bank of Japan was reluctant to intervene again as the Yen surged a week or so ago.  The Ministry of Finance is not keen on breaking this down but we do know that in its QQE (Quantiative and Qualitative Easing) policy the Bank of Japan is a keen equity and indeed property investor. From its latest Minutes.

Second, it would purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.

The Exchnage Traded Funds or ETFs are equity purchases and the J-REITs are property ones. So far just under 7.6 trillion Yen and 300 billion Yen have been purchased respectively. Indeed there are issues building here as regards market stability and structure. From Bloomberg.

the BOJ has accumulated an ETF stash that accounted for 52 percent of the entire market at the end of September, figures from Tokyo’s stock exchange show.


There is much to consider here as we see more and more central banks make the journey to what a Martian observer might have trouble distinguishing from a hedge fund. The elephant in the room is making investments which can make losses. Also here is a conceptual question for you. Is something a profit if it results from your subsequent purchases? The Bank of Japan which is both a template and the extreme case should be mulling this today in response to this.

JAPAN’S 30-YEAR YIELD FALLS TO RECORD 0.335% (h/t @moved_average )

In this situation it may already be beyond the point of no return which poses its own questions as it chomps on Japanese financial assets “like a powered up Pac-Man” as The Kaiser Chiefs put it.

Most other central banks have only taken relative baby steps on this road but we see that in yet another “surprise” even their foreign exchange reserve management is being affected. As I note that the ECB is the central bank mostly likely to dip into equities next let me leave you with a question. How is it that people who are badged as so intelligent and skilled seem to be so regularly surprised by the consequences of their own actions?!

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself (Radiohead Karma Police)




There are building signs of a global property bubble

It was only yesterday that I discussed and analysed the impact of the 60 billion Euros a month QE (Quantitative Easing) program of the European Central Bank. Later that day ECB President Mario Draghi gave himself and his colleagues a slap on the back by describing it thus.

In addition, there is clear evidence that the monetary policy measures we have put in place are effective.

Whilst confettigate occurred soon afterwards I do not think that the protestor who shouted “end the ECB Dicktatorship” was protesting this point,sadly. After all Mario was fulfilling one of the themes of this blog by shamefully attempting to take the credit for the economic boost to the area provided by the fall in the price. Perhaps with the Brent Crude Oil benchmark surging through the US $60 level he felt he had better be quick before it fades away!

However more quietly there was another impact on the day which was a further fall in bond yields as for example the ten-year yield of Germany has now fallen to 0.1% and in some ways even more extraordinarily the equivalent for France is 0.29%. Yesterday I pointed out that this was likely to be causing asset price inflation. So let us now also factor in the preceding efforts at QE from the Federal Reserve, Bank of Japan, Bank of England and Swiss National Bank (via investing its foreign currency reserves) and look at an impact of this.

Global Property

As bond yields fall in so many places investors looking for an income find it ever harder and they have to look elsewhere. This is symbolised in a way by the fact that the time it has taken me to write a paragraph the German ten-year yield has fallen to 0.09%! In such an environment bricks and mortar are something which investors can turn to as they appear physically at least to be an oasis of stability. But what happens if a tidal wave of cash heads in its direction? MSCI have pointed out some consequences. From the Financial Times.

Globally, property generated total average returns of 9.9 per cent in 2014 thanks to rapid capital value appreciation, MSCI found — the best performance since 2007 and the fifth consecutive year of increasing returns.

Okay so happy days for existing investors as well as hinting at how we got into our current malaise. You will not be surprised to read about the leaders of this particular pack.

UK real estate returned 17.9 per cent in 2014 while the US returned 11.5 per cent…..In London returns topped 20 per cent…… price rises in Dublin drove the total return in its real estate markets to hit a record 44.7 per cent — the best performer of all world cities in MSCI’s analysis.

Celtic Tiger mark two anyone?

But there is more.

MSCI found listed real estate companies had also significantly outperformed the world’s booming equity markets. Globally equities generated a 10.4 per cent return, but property stocks returned 19.5 per cent.

So the equity markets which of course are seeing their own QE boost with new high after new high being reported are being left behind by global property markets right now.

Yield and Rent

In essence this is the driving force as places which used to provide it such as sovereign bonds no longer do. So is it all about the rent? The catch is that whilst it is doing well when compared to a plummeting bond yield the outright position is much less cheery.

This is particularly the case in the US, where investors’ returns from rental income are now lower than before 2008, when a crash in massively overleveraged property triggered an international banking slump.

What could go wrong? Also the US is by no means alone.

Most global markets are at or close to historic low [yield] levels,

Of course faced with such a situation there is an inevitable response.

People are moving up the risk curve into riskier locations and taking on higher levels of debt and more challenging development activity.


To get a proper bubble we need for there to be substantial flows of money into that area from new and sadly usually credulous investors so what signs of that can we see?

the voracious spending — dubbed a “wall of capital” — has now spread out into riskier markets…….European QE was likely to boost real estate prices further, Mr Hobbs warned. “QE is sucking in real estate capital because debt finance is so cheap,” he said.

In the past year investment cash has poured into continental Europe — particularly the periphery — MSCI found.


Just under a year ago a sports shop on the Kings Road in Chelsea closed and it did so due to this. From the Evening Standard.

Michael Conitzer, who runs the shop, said he can no longer afford the rent, which was raised by 50 per cent at the review last year to more than £700,000.

My custom of the occasional T-Shirt and shorts purchase was clearly never going to finance that! But if we travel to a land down under to coin a phrase  we see the same thing according to the comments to the FT article.

In a suburb of Melbourne, in the high street and across the lane from a railway station, there is a shop that was brand-new 5 years ago and that has remained empty ever since. The asking rent was too high. Now, it has two adjoining shops that are also empty. (Alfred Nassim).

It got this reply from across the atlantic.

In a suburb of New York City, many of our favourite local restaurants have closed down over the last several years – the reason given by the owners was invariably:  “rent increases, can’t make ends meet”. (User_7995).

Not Everybody Agrees

The OECD compiles a price to rent database and concludes that whilst there are countries with severe imbalances (New Zealand heads the list) overall the situation is actually undervalued. Mind you it shows Ireland as undervalued as we wonder how  last years surge in prices in Dublin will impact the next set of data.

Also Jonathan Gray of Blackstone disagrees but then you could argue that he has a vested interest here.

Blackstone,the world’s largest private real estate investor,,,,,,Mr Gray just made a $26.5bn bet on the global property market.


There is much to consider here as we observe central bankers pumping up the volume in terms of providing liquidity and wonder where the hammer will fall? Of course consumer inflation measures are invariably neutered in this area as they mostly exclude asset prices. Thus asset price gains are presented as an increase in wealth and expected to increase economic output. For those who own property some of that is true as house price growth in the UK for example, has in the last couple of years has exceeded wider inflation and wages by quite a margin. But what about those who do not own property? Either they are left out or they face even higher prices and so they are not richer but are poorer. This leads to a generational issue as the asset rich are mostly older and the asset poor mostly younger. Accordingly my view is that this is more of an asset and wealth transfer than an increase in it.

But if we return to the QE reducing yields issue then we find ourselves mulling this from Germany. The numbers are for institutional property investment.

 The rental yield, including sunk costs, works out around 3%, with tax breaks if you hold for 12 years.

Or a bond yield fast heading to zero. Again what could go wrong?

Once this plays out and these matters invariably take longer than you think which market will central bankers pump up next? As to a musical accompaniment whilst you are thinking this through let us try Joe Walsh of the Eagles.

So I’m floating on a bubble while the world goes down the drain.
Slipping on the soap, running out of rope,
But all and all I can’t complain,
And that’s the rub according to the rules of the game.
The world’s going down the drain,
When the bubble bursts you might as well drink the cork and pop the champagne.
When the bubble bursts, the world goes down the drain.