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Trump Pick Could Drive Paradigm Shift in Central Banking

S&P Global Ratings

COP24 Special Edition Shining A Light On Climate Finance

S&P Dow Jones Indices

Considering the Risk from Future Carbon Prices

S&P Global Ratings

Plugging the Climate Adaptation Gap with High Resilience Benefit Investments

Empowering Public Private Collaboration in Infrastructure

Trump Pick Could Drive Paradigm Shift in Central Banking

Central bankers are being forced to challenge their own conventional wisdom on the interplay between rates and inflation, and the next chair of the Federal Reserve will have a big say in what any new policy paradigm may look like.

The Fed, the Bank of Japan, the European Central Bank and the People's Bank of China may all have new bosses by 2019, which along with personnel changes at the Bank of England will lead to the departure of the generation of central bankers who steered the global economy through the crisis with an unprecedented era of easy money.

Despite the return of economic growth and tumbling unemployment, ultralow rates and trillions of dollars' worth of quantitative easing, or QE, have failed to push inflation back towards central banks' targets, raising the possibility that their conventional monetary policy tools are inadequate and some of their models broken.

"The frustration for all G7 central banks is that recoveries since 2009 have mainly been output-driven, and with output gaps slow to close and wage pressure still capped, they've yet to generate enough inflation to trigger central banks' usual reaction functions," said Neil Williams, chief economist at Hermes Investment Management.

"This — and hopefully the dawning realization that, by prolonging liquidity injections and ultralow rates, central banks may now be contributing to the problem — suggest newcomers may offer alternative paradigms."

As the custodian of the world's top reserve currency the Fed has an unequivocally global role, and the U.S. economy's advanced position in the post-crisis cycle means the next Fed chair may well set the tone for "post-QE" monetary policy.

Fight for the Fed

Kevin Warsh, one of the front-runners to succeed Janet Yellen as Fed chair in February 2018, has attacked what he sees as "groupthink" from global central banks post-crisis, and in a speech in June 2016 called for a "new paradigm" for monetary policy.

Warsh, who was a governor on the Federal Open Market Committee between 2006 and 2011, toward the end of which time he voiced criticism of then-Chair Ben Bernanke's second round of QE, has advocated a softer focus on the target of 2% inflation, arguing instead for a "comfort zone" of around 2%. He wants FOMC members to be happy for policy to "lean against the wind" and to be less reactive to data and market movements.

Jerome Powell, John Taylor, Gary Cohn and Yellen herself are all said to be still in the running, and while Warsh's stance has been dismissed by some analysts as self-promoting hyperbole, he is not alone in thinking central banks will need a new policy framework going forward.

Stanford economist Taylor, whose eponymous rule is used by many central banks to estimate how interest rates should respond to changes in the economy, has argued for the Fed to tie itself to stricter policy guidelines that would be published in detail, decreasing its capability to enact ad-hoc changes.

Yellen conceded last month that central banks' inflation models could be off "in some fundamental way." She has also pointed to forecasts showing the federal funds rate settling at about 3% in the longer run, a far cry from an average of more than 7% between 1965 and 2000, giving far less scope for rate cuts.

Bernanke, Yellen's predecessor, said this month he was not confident "the current monetary toolbox would prove sufficient to address a sharp downturn." He proposed "temporary price-level targeting" — a compromise between permanent price-level targeting and raising the inflation target above the current 2% level — as one response to a lower long-run equilibrium level of real interest rates.

New solutions

Policymakers in Europe, the U.K. and Japan have also suggested rates may, for the foreseeable future, peak at lower levels than pre-crisis, and are discussing tweaks to their own models.

"Extending current inflation targets, broadening them to nominal GDP, and/or adopting, Fed-style, a dual mandate, are all being dusted off and may have their place," said Williams.

"None is perfect, but, if central banks truly want to get their power back, in terms of reclaiming their cherished policy rate, while demand inflation remains in the doldrums, an essence of the Fed's dual target may make sense for others too."

While Mario Draghi's term as ECB president runs until late 2019, investors are already wary of the "key man risk" attached to his departure, especially given Germany's Jens Weidmann — a serial dissenter on the governing council — has emerged as an early front-runner for the job.

"Draghi has drastically changed the ECB and molded it in his own image," said Claus Vistesen, eurozone economist at Pantheon Macroeconomics. "He has redefined the inflation target, and he has been key in gathering momentum behind the current policy tools."

Vistesen believes the ECB and the BoJ face the same kind of challenges in exiting their easy policy stance before running into the next recession, and that the Fed's attempt to do so could be instructive.

"The BoJ never managed to raise rates in a meaningful way before they had to start QE again," he said. "The Fed is keen to normalize policy, they want some bullets in the gun before the next recession happens. That should inform the ECB on QE and rates."

Challenging beliefs

Whoever leads the G7 central banks through the next decade, they will be expected to answer the question to which "worryingly, no one really knows the answer," according to Claudio Borio, head of the monetary and economic department at the Bank for International Settlements.

Namely: Why inflation remains so stubbornly low despite developed economies approaching full employment and unprecedented central bank efforts to push it up.

In a speech last month, Borio said economists "should not take for granted even our strongest-held beliefs," and suggested that the impact of factors such as globalization, technology and even monetary policy itself on inflation and real interest rates was not properly understood.

Indeed, the new intake will also have to confront the possibility that the conundrum they are tackling has either been caused, or at least exacerbated, by the intervention of their predecessors, said Williams.

"I suspect we may be at the point where less will be more, and that part of the reason for wage sluggishness and low productivity is expectations of ticking along at ultralow rates," he said.

"With quantitative tightening offering a second lever to pull to take the weight off interest rate rises, this should not preclude rate rises, but help rates to eventually peak out at lower levels than we're used to."

COP24 Special Edition Shining A Light On Climate Finance


− Green loans are evolving, with the Climate Bond Initiative forecasting nearly $1 trillion in green bond issuance by 2020.

− Despite the uptick in green bond and loan issuance, the market still remains relatively small, especially compared to the universe of assets comprising CLO 2.0 transactions.

− In our view, a green CLO market has large growth potential, boosted by regulatory initiatives and emerging interest from both issuers and investors in 2018.

− We built a hypothetical rating scenario for a green CLO to compare and contrast the underlying portfolio and structure with a typical European CLO 2.0 transaction.

− Our hypothetical green CLO analysis showed that green loans may have different fundamental characteristics to corporate loans, such as lower asset yields, higher credit quality, and higher recovery rates assumptions.

The global collateralized loan obligation (CLO) market has experienced a rebirth (2010 in the U.S. and 2013 in Europe). New issuance continues to increase due to investor familiarity with the product, as well as low historical default rates. While a market for green assets, such as green loans and bonds has been established for a while, although still of a relative size, a sustainable securitization market is still in its infancy. Considering the challenge in financing the amounts, S&P Global Ratings expects green CLOs to play a role in increasing the private sector presence in the sustainable finance market.

Following the Paris Agreement that came into force in November 2016, 184 parties have ratified the action plan to limit global warming. For this purpose, developed nations have pledged to provide $100 billion (about €87 billion) annually until 2025. As part of this deal the EU has committed to decrease carbon emissions by 40% by 2030. In March 2018 the European Commission (EC) proposed the creation of environmental, social, and corporate governance 'taxonomy', regulating sustainable finance product disclosures, as well as introducing the 'green supporting factor' in the EU prudential rules for banks and insurance companies.

Read the Full Report

Considering the Risk from Future Carbon Prices

Along with the advent of the 2015 Paris Climate Agreement has come a growing understanding of the structural changes required across the global economy to shift to low- (or zero-) carbon, sustainable business practices.

The increasing regulation of carbon emissions through taxes, emissions trading schemes, and fossil fuel extraction fees is expected to feature prominently in global efforts to address climate change. Carbon prices are already implemented in 40 countries and 20 cities and regions. Average carbon prices could increase more than sevenfold to USD 120 per metric ton by 2030, as regulations aim to limit the average global temperature increase to 2 degrees Celsius, in accordance with the Paris Agreement.

S&P Dow Jones Indices launched the S&P Carbon Price Risk Adjusted Indices to embed future carbon price risk into today’s index constituents.

Read the Full Report

Plugging the Climate Adaptation Gap with High Resilience Benefit Investments


- Adaptation financing needs to substantially increase to address the higher impact of extreme weather to society due to climate change.

- Adaptation projects are typically cost effective and bring wide range of resilience benefits.

- To demonstrate the value of resilience benefits to various stakeholders we consider that it is important to quantify those benefits based on a robust modeling framework.

- We expect that due to the large size of the adaptation gap and constrained public finances,private investment would need to make a considerable contribution to adaptation financing.

Dec. 07 2018 — We believe the recent surge in economic damage from extreme climatic events may focus the attention of public authorities about the need for adaptation investments and accelerate investment in this area.The United Nations Environment Program (UNEP) forecasts adaptation costs in developing countries at between $140 billion and $300 billion by 2030, and $280 billion and $500 billion by 2050. That is approximately 6x-13x above the amount of international public-sector finance available today--just to meet 2030 costs.

Over the last two years,the world has seen a flurry of extreme weather, which has exposed the vulnerability of many countries to these events. Climate change may make matters worse, irrespective of whether we manage to keep global warming to 2 degrees Celsius or not. Attention to climate change adaptation is therefore increasing, especially about how to finance it, given the need to raise enough public and private investment to fortify exposed countries and communities against the potentially devastating effects of physical climate risk.

Read the Full Report

Watch: Empowering Public Private Collaboration in Infrastructure

S&P Global CEO Doug Peterson speaks with Maha Eltobgy from the World Economic Forum, on their joint study that looks at how greater collaboration between the public and private sector can accelerate national infrastructure programmes.