By Danielle Singer
Since the global financial crisis, major central banks have used unprecedented tools, such as bailouts and buybacks to support the economy and instill stability. By 2009, the US Federal Reserve, Bank of England, European Central Bank (ECB) and Bank of Japan, among others, had laid the foundation for what, over the subsequent five years, would prove to be extremely loose monetary policy to help global markets and economies regain their footing. In both formal and informal coordinated efforts, these influential central banks successfully created a sentiment for risk-taking that saw equity and other risk asset prices taken to new highs. Commentators compared this monetary stimulus to a punchbowl that keeps partygoers in high spirits.
While the impact of this seemingly perpetual punchbowl has been positive, there are long-term tradeoffs of extended loose monetary policy that can cause pressure on a fragile, recovering economy. However, inflationary pressures have been kept at bay so far. More perilous in the near term might be the chances for policy error in manufacturing and executing an exit strategy. Just as forward guidance, or the act of signalling about the future path of interest rate policy, has proved to be an important tool for central bankers, we have also seen that the simple mention of tapering asset purchases can lead to market panics.
A glimpse of this was revealed by the violent reaction of global markets in May and June of 2013 when US Federal Reserve chairman Ben Bernanke hinted at the potential for the tapering of quantitative easing (QE). Perhaps investors do not have enough confidence in the sustainability of the recovery and global growth to have the punchbowl pulled away. What once appeared to be a coordinated effort by central banks is now beginning to show signs of divergence, as each central bank needs to focus on what steps it will take to repair its own economy.
While the US may plan on tapering its asset repurchases, which were growing by about 0.5% of GDP per month, liquidity may still be plentiful thanks to aggressive QE programmes by other central banks. The Bank of Japan’s governor Haruhiko Kuroda has indicated that it will expand its balance sheet by roughly 1% of GDP through 2014. In the US, while tapering is likely for the Federal Reserve during 2014, if economic data show signs of strength, rate hikes still appear unlikely before late 2015, unless inflation becomes a problem. Unlike many other industrialised country central banks, only the ECB remains relatively hawkish.
While the path and effectiveness of continued quantitative easing programs remain to be determined, we do believe that the increased volatility that has come along with this uncertainty is likely to persist. Questions remain about the European Central Bank’s efforts being undermined by an inability to form a cohesive fiscal and banking union. These pervasive macro-economic questions could trigger increased volatility and market dislocations offering opportunities for investors. Additionally, there has been significant improvement in economic data and growth due to strong central bank action. US house prices have rebounded, and most economies – including the eurozone – have come out of recession. Overall, we believe that central banks are committed to remaining accommodative until growth goals are met, and that they will help achieve a continued global recovery.
Danielle Singer is US strategist at UBS Global Asset Management
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