Week In FX Europe - Central Banks, Debt Agencies And Governments Have To Work Together

by: Dean Popplewell

Are we about to face a period of "considerable turmoil"? Central Banks in the developed world are preparing to reverse some of the stimulus programs that they have put in place over the past six-years. The Paris based research body - OECD - insists that the agencies that have been responsible for selling government bonds will have to work with their respective Central Banks to ensure that the "exit from all said programs run smoothly."

The reversing of stimulus needs to come, but the potential problems have more to do with Central Banks communicating their respective exit strategies without creating unnecessary volatility that could cause longer lasting negative effects. The challenge for Central Banks and relevant agencies is to go about their "exit" strategy without causing yields to back up aggressively. Central Banks have yet to decide on what portion of their holdings they will be required to sell and over what time period.

The OECD said that bond sales by Central Banks would likely take place when the borrowing needs of governments remain high - this will obviously lead to interest rates to back up further. Backing up is only natural; it's the speed and aggressiveness that could become an issue. Already we have seen that investors reaction to a Fed taper has caused U.S. yields to "move earlier and more sharply" than probably warranted by policy makers. This is not a good situation for any economy that has questionable growth rates. The reality is that this is all new for Central bankers and investors alike. Tapering has been a novelty and reversing this stimulus has never been done before. With that in mind it may not be possible for the financial markets to execute an exit without at least causing some minor financial turbulence.

Expect to hear unified dulcet tones from Central Banks, governments and debt management agencies getting louder as we approach an exit.