1st Central Bank and Reserve Funds Summit

CFA Society New York’s Asset Owner Series presented the Central Bank and Reserve Funds Conference which was a full day event featuring speakers from the Federal Reserve Bank of Chicago, Banque de France, United Nations, Global Sovereign Advisors, Banco de Mexico, Societe Generale, International Finance Corporation, Bank of Korea, Reserve Bank of Australia, Italian Central Bank, Standard Chartered Bank, European Investment Bank, Central Bank of Hungary, and leaders from CFA Society NY.  The comments expressed do not represent any of the central banks viewpoints and information presented is not reflective of internal research or recommendations.

In academia, volatility is a proxy for risk which will tell you that price captures all relevant information.  In practice though, that is not the case.  Volatility a measurement of risk and a gage or indicator of the emotional condition of a market.  Volatility considers fear, greed, and complacency.  There are expectations of higher levels of volatility as complacency was a thing of the past.  Derivatives may help mitigate higher volatility. 

When analyzing the low rate environment, it is important to remind the investor to look at rates on a real basis, or after inflation.  There is a challenge to manage assets properly in a world of low and negative real rates.  While this problem has been around for years, central banks across the world are beginning to reduce the maximum accommodation leading to higher short term rates and reduced negative real rates considering inflation has remained benign.  Negative rates don’t always mean negative returns as yields can fall, and investors can achieve positive capital gains.  Though in this environment, it’s challenging to bet against rising rates.  Central banks have specific mandates and a number of tools to meet them, negative interest rates are part of the tool box.  Rising interest rates are warranted if they are a function of rising Inflation.  Higher rates are welcomed by many investors as they provide an opportunity to earn a higher yield.  When determining if rising rates are a threat to markets, it is important to analyze the magnitude of the rise in rates. If slow and relatively predictable as witnessed at the Fed, markets can handle the rising rates.   

Central banks have positioned themselves more conservatively since the financial crisis to improve governance and event risk.  One of the goals of central bankers is to avoid another financial crisis or create stability during the next economic downturn.  Across the globe, sound central bank frameworks have been put in place post the 2008 crisis which has involved stress tests, excess capital, and better tools for managing heightened negative volatility.  In regards to debt to GDP, rather than focusing on today’s ratios, central bankers are more concerned with the trajectory and where ratios will by 5 years from now.  Gold reserves can lead to positive public perception given its historical store of value.  Central banks in Germany, the US, France, and Italy hold the most gold and tend to use it to lend.  There is a cost to holding a hard commodity in your vaults so the yield from loans must outweigh the storage costs.  Central bank reserve management is done through a combination of things such as diversification and strategic asset allocation.  While diversification is normally thought of as investment allocations, from the highest decision making level, it is important to be careful of groupthink.  Crashes tend to occur when accepted wisdom proves false.  Having diversification in terms of varying views and opinions is imperative.  Objectives of a central banks reserve portfolio may be minimizing the potential drawdown, mitigating reputational risk, having high liquidity given the shorter duration, a strong governance, asset diversification, and ultimately price stability.   Current issues in reserves management include income generation, currency hedging to counter a weaker dollar, and active portfolio management in a normalizing yield curve. 

While the next crisis is extremely hard to forecast, one thing to consider are investors taking on more and more risk in order to achieve higher returns.  With bond yields falling for the past 30 years and equity prices rallying considerably post the 2008 financial crisis, we are at a point where expected returns are lower.  In order for investors to continue to meet their return requirements, they may be inclined to move farther down the risk curve.  One must remember, the farther you walk down the branch of a tree, the more likely that branch will snap.

In terms of attracting and retaining the best talent, it is not money that drives people to become central bankers.  The opportunity to engage in public service, opportunity to move around, being an international civil servants, creative work, direct access to markets, work/life, and most importantly, the ability to have a direct impact on the world.  The biggest benefit is contributing to something bigger than oneself.

2018-04-26T16:27:54+00:00 April 25th, 2018|Categories: Galleries, Gallery, Past Events, Previous Event Galleries, Recaps|