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What Are Central Bankers Thinking?

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Until Banks have spread to make net income, they will be reluctant to expand lending.

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The European Central Bank decided to talk tough on inflation about a week ago and I think that caused some of the selling we have seen since the beginning of the year. The decision by the Bank of England to leave rates unchanged didn't help either. The perception, though false, is that the ECB's and BEO's hawkish stances crimps our Fed's ability to act.

It seems central bankers are all using the same play book, despite the poor results the plays produce. I'm not talking about stock results per se, I'm talking about credit markets and sustainable economic growth. They are playing an incredibly dangerous game when it comes to the risks facing leading banks, brokers and the bond insurance companies.

Until the market turns or someone with the power to enact change starts listening, banks and other financial institutions need spread, positive carry, low risk interest income -- whatever name you want to give it. Until they have spread to make net income off a favorable risk reward duration trades, they will be reluctant to expand lending.

Further, the "risk free" rate needs to be such that the big buyers of bonds feel like they can get a reasonable return for taking the risk of owning debt other than bonds backed by sovereign nations. The risk free rate (Fed rates) needs to be around and preferably below the levels of shorter term U.S. Treasuries. This dynamic was a key ingredient for banks to heal from the Savings and Loan crisis.

Central Banks are supposed to offer some of the best intellectual capital in the world with contacts in every leading global financial institution, nearly every conceivable piece of data and the computing power to match. So what are these central bankers thinking? What is the agenda? Do they really think inflation is a multi-year problem and they have just decided now is the time to put the massive sting on it, thus quelling a dangerous potential surge? Or are they just flat out wrong and their focus and forecasts have completely missed the mark?

The easy answer is they are just wrong -- and this is what I think. And while they may have some sound reasoning to take these actions that the world does not yet see, the thought of giving them the benefit of the doubt sends chills down my spine.
No positions in stocks mentioned.

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