Central banks speculating in equity-markets: What could possibly go wrong?

Yesterday, in Congressional testimony Janet Yellen apparnetly felt it was within her mandate as Chair of the Federal Reserve to slap a “sell rating” on social media stocks and bio-techs.

The smack-down of two sectors certainly raised eyebrows. Why?  Because it was one more disturbing sign of increasing Federal Reserve involvement in equity markets.  The big question however, still remains at large:  Is the Fed buying stocks?  For those who would scoff:  This isn’t a remotely far-fetched question, although it was not long ago that the mere suggestion that central banks were buying equities was firmly in the domain of conspiracy theorists.   Today its the current trend among many of the world’s largest central banks — Japan and Switzerland being prime examples.

Traditionally, central banks have been relatively boring institutions.   Policy tools have historically been crude and far less controversial.

Today things are not so simple.  Central banks are buying stocks.

Don't worry.  They're hedged.

Don’t worry. They’re hedged.

With interest rates at all-time lows and the entire investing-world desperately seeking yield, global central banks are buying equities to make up for yields traditionally generated through more traditional means.

The South China Morning Post reports:

Now it seems that [central banks] have become important, too, in building up holdings of equities to increase depleted yields on their much-increased reserves of foreign currencies.

Central banks may be overstretching themselves.

Evidence of equity buying by central banks and other public-sector investors has emerged from a new, comprehensive survey of US$29.1 trillion worth of investments held by 400 public-sector institutions in 162 countries.

Here’s the problem:  Central banks are supposed to be the institutions of economic stability.  Now we’re talking about central banks buying and selling equities hand-over-fist during the same period when markets are soaring to new highs.   It’s one thing to blame central banks for asset bubbles because their monetary policies are “too loose”.   It’s quite another thing to recognize that central banks are directly contributing to the current bubble in equity markets by buying stocks.   Is it any wonder these massive market participants don’t want to admit there’s a bubble?  

Much has been written about markets being manipulated by high-frequency trading and indexes being goosed by easy-money.  But how much is said about direct central bank equity investing?  One must note:  Central banks are trading equity markets to replace revenues traditionally generated from bond yields — which they themselves have suppressed.

Central banks have been trying to compensate for lost revenue caused by sharp falls in interest rates driven by official institutions’ own efforts to repair the financial crisis.

According to calculations by the Official Monetary and Financial Institutions Forum, central banks around the world have foregone US$200 billion to $250 billion in interest income as a result of the fall in bond yields in recent years.

This raises uncomfortable questions:  Are central banks long?   How long?   Do they short?   What’s the nature of their trading?

In case you’re wondering if there’s any transparency:  No there isn’t.   Central Banks are not bound by the same “Santiago Rules” of transparency that govern sovereign wealth funds.

How exposed are the world’s central banks to devastating losses in the event of a collapse?    Nobody knows.   

The Bundesbank is one of the few central banks that has voiced strong concern over this trend:

Jens Weidmann, president of Germany’s Bundesbank – which retains a highly important role in the euro area – spoke yearningly last week of the need for “central banks to shed their role as decision-makers of last resort and, thus, to return to their normal business“.

He said this “would help to preserve the independence of central banks, which is a key precondition to maintaining price stability in the long run”.

But Jens, what exactly happens when banks do actually “return to their normal business“.   And will we get a heads up?