The global economy started 2014 off with moderate strength.  Since then, its status has been downgraded to moderately weak. Entering 2015 with this background, there’s one question investment bankers certainly have on their mind. Which of the big 6 central banks will cause investment bankers the most heartburn in 2015? Let’s take a look.

European Central Bank (ECB)

The ECB appears the most dovish of all the major central banks. It has been six years of loose monetary policy in the Old World (September 2008 was when the ECB first made it’s move).

Recent indications from ECB President Draghi continue the uber-dovish tendency, indicating that the ECB will likely take steps to expand its balance sheet.  The ECB’s balance sheet expanded quickly from May 2011 to June 2012.  Since then, the ECB has watched its balance sheet decline by about 100% (dropping from +178% in June 2012 compared to January 2007 to 78% in September 2014).

The continued weak nature of the ECB certainly puts the ECB close to the top of concerns for investment bankers, but in this case, the concern is most likely a positive concern.  Investment bankers as a group generally want weaker monetary policy.

European Central Bank

Federal Reserve (Fed)

Akin to the ECB, the Fed has been incredibly dovish since August 2007 (the month the Fed started lowering its main policy rate). In addition to questionable policy motivations behind historically low interest rates, the Fed has also been quite active in expanding its balance sheet. Since January 2007, the Fed’s balance sheet is up about 415%.

The question now is – will the Fed be able to raise rates before implementing further balance sheet expansion (i.e. QE 4)? The (perhaps futile) debate about when the Fed will raise rate certainly puts Ms. Yellen and members of the Federal Reserve Open Market Committee close to the top of central banks that investment bankers should be worried about.

Federal Reserve

People’s Bank of China (PBOC)

The PBOC has been much more prudent in manipulating short-term interest rates and expansion of its balance sheet, with its balance sheet up “only” 125% compared to the Fed’s 415%.

Interestingly, the PBOC has become markedly more weak in its policy stance, recently lowering its main policy rate from 6% to 5.6%.  The somewhat surprising policy rate change coincided with some announcements on expanding its balance sheet in minor ways.

With PBOC flipping to a dovish stance, the PBOC is unlikely to give investment bankers much to worry about, unless, of course, strong price appreciation materializes.

People's Bank of China

Bank of Japan (BOJ)

Akin to the ECB and PBOC, the BOJ recently shifted to a quite more dovish view. This view, no doubt, stems from two consecutive quarters of negative GDP growth. With the BOJ unlikely to give any attention to normal monetary policy in 2015, the BOJ will likely be an afterthought for the world’s central bankers this coming year.

Bank of Japan

Bank of England (BOE)

Akin to the Fed, the BOE has been quite active at expanded its balance sheet during the financial crisis. Additionally, the BOE has been implementing loose monetary policy since September 2008.

With no indications out of BOE that rates are to rise any time soon, BOE’s monetary policy situation is unlikely to garner much attention in 2015, barring any surprises.

Bank of England


Of the six major central banks, the Central Bank of Russia has raised rates significantly recently, with its main policy rate rising from 5.5% in February 2014 to 8% currently. The rise, of course, stems largely from a concern about foreign capital flight due to the situation between the Eastern power and Ukraine.

The question with Russia is – how much might does it want to employ in dealing with western aggression?


Contrasting the Six Central Banks

Which of these 6 central banks are most likely to cause the  most heartburn for the world’s central bankers?

Of the 6 mentioned, only two are even considering raising interest rates – Russia and the U.S.  Which is most concerning? This subjective question, of course, has no answer.

On the one hand, the U.S. is the second largest global economy with the most used currency on the globe.  Any mistakes from Federal Reserve bankers could send the U.S. into a recession, or at least weaken the mighty power akin to the weakness the European economies are experiencing.

On the other hand, Russian policy could severely weaken European growth (simultaneously hurting itself, of course).  The ruble is nowhere near as powerful as the dollar, placing greater weight on American policy when viewing the question through this lens.

Overall, the answer to the question is left to the reader.


The global economy will enter 2015 with an elevated level of uncertainty about the strength of the global economies. If things go according to indications out of the central bankers right now, it may very well be the Americans that make investment bankers the most displeased, although the Russians certainly have a say as well.

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Among the more hotly debated issues in the investment banking world is the issue of government spending, and in particular government spending in Europe. The fundamental question is: Should European nations continue to reduce the costs of government services (i.e. reduce government spending to the point of a balanced budget)?

Germany answers this question with an honest yes.  France and other struggling EU members say no, it’s politically unfeasible. So far, the Germans are proving to be correct, at least according to the simple correlation evidence.

Advocates for Greater Government Spending

On the one side of the debate are left-leaning investment bankers (there are more than you think), and government and academic economists, who simply think government spending is the easiest way to improve economic growth. Individuals with this somewhat naive view generally justify their thinking by employing the use of the “government spending multiplier.” The government spending multiplier represents the idea that an increase in government spending induces firms and individuals to expand spending, and thus improve the economic outlook.

Advocates for greater reliance on government spending point to, for example, governments paying private firms to construct buildings or build railways as “proof” of the effect of government spending.

The Government Spending Realists

On the other side of the debate are most of the investment banking world, non-academic and non-government economists, and most business leaders.  Individuals with this view could accurately be classified as government spending “realists.”  Government spending realists see the usefulness of government spending at certain points in the economic cycle, but also acknowledge that government spending is in no way the way to improve prolonged economic growth.  Instead, government spending is almost always correlated with reduced economic growth when looking over many years.

Overall, government spending realists generally see government spending as something to be minimized when possible, even when politically unpopular.

Debate Aside.  Here’s a Look at Government Spending.

Acknowledging the long-standing debate, we can now inspect the evidence.

First, here’s the government spending side. The following table inspects shows what government spending has done by certain European governments since 2009.

Growth in Government Spending since 2009


Interestingly, of the nations shown, the biggest spender since January 2009 to October 2014 is the Italian government, up 73%. Other governments with larger spending increasing include Finland (72%), Belgium (32%), Luxembourg (29%), and Spain (22%). On the other side, the “prudent” governments include Greece (down 39%), Switzerland (down 3%), Netherlands (up 1%), Ireland (up 4%), Germany (up 8%), Denmark (up 8%), the U.K. (up 10%), and Sweden (up 13%).

Next is a look at government spending across 16 so-called advanced economies.

Government Spending Dashboard1 Government Spending Dashboard2 Government Spending Dashboard3

Debate Aside.  Here’s a Look at GDP Growth.

Switching to GDP, GDP is the broadest measure of economic growth.  When academics talk about government spending and try to connect its effect, they usually do so by trying to connect government spending with GDP growth.

The following graphic is what GDP growth has done over the past few years. The best performing economy of the economies shown is Australia, up 20% since 2007. On the other end, the worst performing country is Greece, down 25%.

Growth in GDP since 2007 by Nation

Connecting Government Spending and GDP Growth

With the two components addressed, the question can now be answered. Are the Germans or the French right?  Is reducing government spending causing havoc on European economies? The accurate answer to the latter question is no, implying that the Germans are right.

Consider, for instance, Italy, which has seen the largest expansion in government spending while performing the second worst. On the flip side, Greece has reduced government spending the most and has also experienced the worst economic performance.

The contradictions continue. Switzerland, which over the period covered has reduced government expenditures second most (down 3%) has experienced the third best economic performance. Finland, with the second largest increase in government spending, has experienced the the fifth worst economic performance of the economies listed.

If this were an academic paper, the next step would be to present scatterplots, panel regressions, and other econometric evidence.  What it would show is exactly what was just said – government spending is not the cause of poor European economic performance.


Overall, the Germans and most of the investment banking world are right – reducing government spending is not the cause of poor European economic conditions.

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For the third time in the past 5 years, the Federal Reserve officially ended an experiment with quantitative easing (QE), known this time around as QE3 (uncreatively, the prior two became known as QE1 and QE2). The end of quantitative easing presents the next obvious question: When will the Federal Reserve hike rates (ignoring for the moment, of course, whether the Fed might implement QE4 before any rate hike)?

The current “consensus” among economists and other Fed watchers is that rates may rise sometime in June 2015.  But, is it likely that the Fed will really be able to raise rates in 2015?

Political Nature of the Fed

One overlooked component among Fed observers is the political nature of the U.S. central bank.  Statutorily, the Fed’s sole responsibility as a political institution is to balance maximum employment with low inflation in the most prudent manner possible.  This vague dual mandate (at least in implementation) leaves lots of room for the Federal Open Market Committee (FOMC) to generally listen to whatever voices seem politically or economically reasonable.

A Little History on the Fed Funds Rate

Given the political nature of Federal Reserve policy, one might ask: What has the Federal Funds rate been by U.S. president? The following graphic is a look at this issue from the effective Federal Funds rate perspective (please note that the y-axis is scaled differently for every president).

Federal Funds by President (Different Scaled Axes)(1)

Starting from the top, President Eisenhower saw two tightening cycles during his presidency, although the effective Federal Funds rate never got much above 4%. Second from the top is President Kennedy.  The graph is shortened because of Kennedy’s assassination.  Overall, Kennedy’s entire presidency was generally one of tightening, with the Fed’s effective rate reaching around 3.5% at the end of Kennedy’s life. Third from the top is President Johnson.  Akin to President Eisenhower, President Johnson saw the Fed implement two tightening cycles during his tenture, with the Fed Funds rate reaching a little over 6% at the end of his Administration.

Following President Johnson is President Nixon.  President Nixon came into office with the Federal Reserve in the middle of a tightening cycle.  Shortly thereafter, the Fed began lowering the target Fed rate, bottoming at around 4%.  The Fed Funds rate didn’t stay at 4% very long, with the Fed quickly increasing its short-term borrowing rate up to a high of about 14% at the end of Nixon’s tenure. In contrast to President Nixon, President Ford came into office with the Fed in the middle of a loosening cycle.  Briefly, after about a year in office, the Fed raised its target rate.

Following President Ford was the Carter Administration.  Of all the presidential administrations that would complain about Fed policy, the Carter Administration likely has the most reason to gripe.  After the Fed let inflation get out of control, they hiked interest rates to as high at 20% before Cater lost his reelection bid to President Reagan.  Reagan came into office at about the time the Fed felt it was getting a handle on inflationary pressure.  Thus, the Fed target rate declined steadily to around 5% during Reagan’s second term.  About half way through Reagan’s second term, the Fed initiated a tightening cycle, bring the rate to around 8% at the end of Reagan’s Administration.

Following Reagan’s time in office, the first President Bush saw the Fed Funds rate only briefly rise during the initial few months of his presidency, after which the Fed began addressing the early 90s recession. Interestingly, President Clinton generally saw a stable Federal Funds rate, increasing at the beginning of his presidency, slightly declining towards the end, and then increasing again during the technology boom run-up. Following President Clinton, President Bush (II) saw two very textbook-like loosening cycles and one tightening cycle.

Lastly, President Obama came to office when the economy was just recovering from the housing market bubble.  If one looks closely, the Fed Funds target rate has not been changed during his tenure (the jumps in the graph are the daily cycles in the effective rate; observe the y-axis which shows the effective rate going from 0 to about 0.6%).


With the lack of any movement in the Federal Funds target rate during President Obama’s administration so far, one has to wonder if President Obama will be the first U.S. president to never see a Fed rate hike.  The answer is likely yes.

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