Last month the US Federal Reserve's Chairman sent a shock
wave through equity markets by suggesting the Fed might slow its
programme of Quantitative Easing. Equities and bonds markets took a
knock, with Japan's Nikkei index dropping by over 6.0% in one
day.
Mr Bernanke's comments provide a dress rehearsal for how
markets could react when the world's central banks halt their
programmes of Quantitative Easing (QE).
Over the last five years central bank QE has pumped trillions of
dollars into the global economy. By buying up government bonds, QE
has pushed up their price (and reduced their yield or interest
rates). And by releasing liquidity into the economy QE also seems
to have boosted equity prices.
In the '90s market participants used the term the
"Greenspan put" to describe the way in which the previous
Fed Chairman's easy money policies underwrote equities. Today
the talk is of a QE-driven "Bernanke put" supporting
equities.
The major surges in equity markets in the last five years have
coincided with waves of QE. When the Federal Reserve ended its
first two programmes of QE US equities slumped. But the rally
kicked off again helped by the Fed's announcement of QE3 in
September 2012.
Japan provides another example of the intoxicating power of easy
monetary policy. Since the beginning of this year the new Japanese
government has pushed through a revolution in economic policy. A
long term critic of the conservatism of the Bank of Japan (BoJ) has
been appointed as its Governor. The Bank has been given a mandate
to end Japan's long bout of deflation by pushing inflation to
2.0%. And the Bank has announced an unexpectedly aggressive
programme of QE to push up inflation and growth.
The effects have been dramatic. Japanese equities have risen by
over 70% since the start of the year, the Yen has plummeted and
economists have raised their forecasts for Japanese GDP growth this
year and next.
Almost all forecasters expect growth in the industrialised world
to pick up next year. But the near-universal expectation is that
the recovery will be slow and vulnerable to setbacks.
In the US bank lending, house prices and consumer confidence are
on the rise and a low key recovery is happening. But Europe is
still in recession and the growth outlook has deteriorated in
recent months.
The dilemma for central banks is that the premature ending of QE
risks renewed recession. If they wait too long, they risk creating
asset bubbles and inflation.
Yet the ghost that seems to haunt policymakers is the Great
Depression of the 1930s, not the great inflation of the 1970s.
Central Bankers know that the premature withdrawal of monetary
stimulus in the US triggered a double dip recession in 1937-38.
Today's central banks seem to fear depression more than
inflation.
If that is the case then Central Banks will need to be convinced
that the recovery is entrenched before they finally call time on
QE. Mr Bernanke's remarks underscore that America is ahead of
Europe in this process.
What will be the signal for Central Banks to switch off QE?
Our guess is that a combination of sharply lower unemployment and
rising forecasts for growth over the next couple of years would do
the trick. The US isn't there yet and Europe is nowhere near
there. Central Banks don't look ready to take away the
punchbowl of Quantitative Easing.
MARKETS & NEWS
UK's FTSE 100 ended the week down 1.7%.
Here are some recent news stories that caught our eye as reflecting key economic themes:
KEY THEMES
- US consumer confidence rose to its highest level in more than 5 years in May, according to survey data from the Conference Board
- The European Commission gave France, Spain, the Netherlands two extra years to cut their deficits to the eurozone target of 3% of GDP, extending the deadline to 2015
- The European Central Bank (ECB) reported that loans to Eurozone companies fell by 0.9% year-on-year in April, the 12th consecutive monthly decline
- German carmaker BMW announced a pilot scheme to recruit unemployed young Spaniards to work in Munich for a year, in a programme designed to "give something back" to struggling European customer countries – with the scheme potentially to be expanded to Italy or Greece if it is successful
- China's Shuanghui International Holdings signed an agreement to acquire the world's leading pork manufacturer Smithfield Foods Inc for $4.7bn, a deal that would be the largest ever Chinese purchase of a US consumer brand
- The Detroit Institute of Art has been told that it may be forced to sell some of its world famous art, including works by van Gogh, Matisse and Bruegel, as part of a resolution to pay off the city's estimated $15bn-$17bn debts
- Supermarket chain Waitrose signed a deal with Unimarc supermarkets in Chile, to export goods including quality tea, biscuits, truffles, pasta and mayonnaise to South America
- Britain's hotels, bars and restaurants enjoyed their biggest rise in trade in almost 6 years in Q1 2013, according to survey data from the Confederation of British Industry (CBI)
- Consumer survey data from the Leichtman Research Group showed that around 1% of US households stopped paying for home Internet subscriptions in 2012, to rely instead on wireless access, whilst just 0.4% of households canceled their pay-television subscriptions in favor of Internet services such as Netflix
- Jaguar Land Rover outlined plans to invest £2.75bn in the UK this year following record sales and profits, driven by accelerating demand from China
- The number of retail transactions made in cash fell by 10% in 2012 according to data from the British Retail Consortium (BRC), with just 54% of transactions paid for in cash
- The Royal Mail announced its "click and collect" initiative, which will allow online shoppers to pick up their purchases at their local post office
- Lloyds Banking Group, which is 39% owned by the British taxpayer, sold a portfolio of US subprime mortgages for £3.3bn, making a pre-tax gain of around £540m following strong recovery in the Us housing market
- India's economy grew at 4.8% in the financial year to March, the slowest rate in a decade
- Germany's national railway company Deutsche Bahn announced plans to test small drones to collect evidence against graffiti vandals who deface property at night, at an estimated cost of €7.6m a year – trained eye
Regards,
Ian
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