BREAKINGVIEWS-The Week in Breakingviews: Central bank submission

By Peter Thal Larsen

LONDON, May 10 (Reuters Breakingviews) - Welcome back! Kevin Warsh is scheduled to start work at the Federal Reserve next Friday, the same day that Presidents Donald Trump and Xi Jinping are due to wrap up their summit. Some thoughts on the former below. Send me your predictions for the latter. If this newsletter was forwarded to you, sign up here to get it in your inbox every weekend.

OPENING LINE

“The sun always shines in Michael Milken’s Beverly Hills. The former junk-bond king’s yearly financial Coachella kicked off as a conflict-induced energy crisis spooks consumers increasingly nervous about how they’ll make ends meet. With ​the big money managers in attendance aggressively targeting these same unsettled savers, the inequality gap feels especially surreal.”

Read more: Predators’ Ball revelers keep sunglasses on.

FIVE THINGS I LEARNED FROM BREAKINGVIEWS THIS WEEK

1. Hong Kong’s Airport Authority sold bonds with a yield 1 percentage point lower than U.S. Treasuries. (Debt markets are booming)

2. Buying 25% of Commerzbank would cost the German government 5 billion euros. (A bad idea)

3. The average holding period for private equity buyouts has risen to seven years. (Time to relearn old tricks)

4. In India, 15 of 28 provinces make no-strings-attached payments that reach one-fifth of the country’s women. (The fiscal rot deepens)

5. Two-thirds of cars sold in China last year offered driving assistance. (A new road for Nvidia)

DOMINANT GENES

Barring a last-minute upset, Kevin Warsh will start his new job as chair of the Federal Reserve on Friday. What happens next has profound implications for the United States and the rest of the planet. Will the central bank in the world’s largest economy resist pressure from President Donald Trump to cut interest rates? Or does Warsh’s arrival herald a downgrade of central bankers as guardians of stable prices?

The story of central bank independence is generally told through its leading lights: Paul Volcker slayed inflation at the Fed, Alan Greenspan steered the U.S. through multiple crises, Mario Draghi saved the euro, and so on. These figures doubtless made a difference, but so did the environment. They largely plied their trade in an era defined by deregulation and globalisation. The prevailing view was that free markets should be allowed to work their magic, with central banks as impartial arbiters. Even after the bailouts of 2008, the orthodoxy limped on.

Warsh and his rich-world counterparts inhabit a different landscape. They must navigate fragmented geopolitics, norm-breaking politicians and voters suspicious of technocrats steering their economic future. Whether central bank independence can survive this change of climate is an open question.

ECB Executive Board member Isabel Schnabel this week addressed the shifting environment. In a thoughtful lecture in honour of Charles Goodhart, the economist and former Bank of England official, she catalogued the external threats to independent central banks. The first is that indebted governments lean on rate-setters to keep borrowing costs in check. This is known in the jargon as “fiscal dominance”.

But Schnabel also articulated another concern: that a fragile financial system undermines monetary policy. “A central bank that cannot raise interest rates without risking financial disturbances or a financial crisis is not free to fulfil its price stability mandate,” she argued. The threat of what Schnabel calls “financial dominance” is not idle: banks on both sides of the Atlantic are lobbying to scrap or dilute post-2008 regulations (I wrote about this last month).

Schnabel is right that financial turmoil can upset economic stability, while robust banks help cushion shocks like a pandemic. The problem, though, is that risk-taking has moved into more lightly regulated financial institutions. U.S. private credit funds have extended loans worth more than $1 trillion. A big chunk of trading in government bonds now flows through hedge funds, not banks.

Schnabel and her ECB colleagues would prefer to tighten up oversight of these shadow banks. That’s unlikely as long as the U.S. seems determined to loosen the rules. Regulators face a choice between what Jon Sindreu calls two evils: let risks build up outside the banking system, or let banks hold more government debt. There are few easy answers. Add financial dominance to the long list of challenges facing Warsh and his colleagues.

CHART OF THE WEEK

Most investors know that the average fund manager lags the market. Yet the scale of underperformance remains startling, as this chart of success rates for actively managed U.S. funds demonstrates, based on Morningstar data. Sebastian Pellejero suggests two remedies: remove size limits on single-stock holdings and let fund managers hold more illiquid assets.

THE WEEK IN PODCASTS

If the success of a currency depended on the number of books written about it, the U.S. dollar would be in rude health. In his biography of the buck, “The Almighty Dollar: 500 Years of the World’s Most Powerful Money”, Brendan Greeley argues that the United States inherited rather than invented its currency. He joined me on The Big View to debate the implications of that history, and what it means for the dollar’s future.

International bond investors don’t tend to pay much attention to municipal votes. Yet markets this week were monitoring local elections in the United Kingdom for clues about the future of Prime Minister Keir Starmer’s government. Before the polls opened, Neil Unmack and Jon Sindreu joined Jonathan Guilford in the Viewsroom to debate the possible consequences for Britain’s fiscal future.

PARTING SHOT

Britain used to have hundreds of family-owned private banks. They were wiped out by the arrival of joint-stock lenders which enjoyed limited liability, with one exception. C. Hoare & Co. is owned and managed by descendants of the eponymous founder who hung out his shingle in the City of London in 1672. A new memoir by former Chief Executive Alexander Hoare offers some tips for survival. Edward Chancellor, a longstanding customer, celebrates the bank’s longevity.

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