Central Banks’ Taper Dilemma
Central banks are clearly not responsible for today’s investment decisions, but the longer their market support continues, the riskier the search for yield may become. Monetary policymakers and credit investors alike are facing an unenviable dilemma.
DUBLIN – Central banks’ unconventional policies undoubtedly rescued financial markets in 2020 when the COVID-19 pandemic was at its height. But those actions now leave central banks joined at the hip with credit markets, and market participants more reliant than ever on their support.
From a credit-market perspective, this represents a Catch-22 for both central banks and investors. How can central banks continue to support the economic recovery while developing an exit strategy that doesn’t undermine market stability? And how will investors, who prize stability but also seek higher yields, react if and when monetary policymakers step back from providing direct market support?
With low interest rates for most of the past decade, it was clear from the start of the COVID-19 crisis that central banks had little room for maneuver with conventional policy tools. They would have to lean even more heavily on unconventional measures, including initiating or extending corporate asset-purchase programs. In the case of the US Federal Reserve, the announcement of these measures during 2020 coincided with investment-grade corporate bonds’ peak spread.