3rd July 2013
The US may, possibly, at some point, a long way in the future, start to pare back quantitative easing writes investment journalist Cherry Reynard. Not end it, or reverse it, but just pare it back. And it is this possibility that has got markets in such a lather in recent weeks. For the time being, its impact has been universal, all bond and equity markets have sold off equally, but how will the US’s potential adoption of a different monetary policy to the rest of the world affect its relative economic performance?
Ben Bernanke’s initial comments were relatively mild, simply suggesting that QE would be pared back towards the end of 2013 if the economy continued its current trajectory. After this sent markets into a tail-spin, the Federal Reserve was forced to calm markets by clarifying its position, outlined here on USAToday.
It quotes New York Fed President William Dudley saying: “If labor market conditions and the economy’s growth momentum were to be less favorable than [expected] — and this is what has happened in recent years — I would expect that the asset purchases would continue at a higher pace for longer.”
In other words, the pace at which QE is slowed, or tapered, depends on the data. Bernanke has previously made it clear that the Fed will only end its asset purchases if US unemployment falls below 7%, against a current rate of 7.6%.
For Keith Wade, chief economist at Schroders, Bernanke’s position can be summed up thus: “He expects to start slowing bond purchases before the end of the year and to have ceased by the middle of 2014.” Markets are currently pricing in an interest rate rise at some point in 2014, but Wade believes that this looks ‘a little stretched’ at this point. Jim Leaviss, head of retail fixed income at M&G agrees, saying, “there is no way rates are going up as quickly as the market is pricing in.”
The UK position is a little different. There remains almost no talk of withdrawing QE and many believe that new Bank of England governor Mark Carney may bring in extraordinary policy measures to boost the economy. James Humphreys, Senior Investment Manager at Duncan Lawrie Private Bank says: “Carney is unlikely to turn the QE tap off just yet and in the run up to his arrival he has been championing the idea of an on-going stimulus strategy. He is therefore likely to continue Mervyn King’s stance of trying to encourage other MPC members to vote for an extension of QE… There is a question as to whether QE is enough. Perhaps Carney will launch new initiatives like Funding for Lending to support the recovery.”
Interest rate rises look even further out for the UK than they do in the US – at least two years away according to a consensus of economists quoted by the BBC. Sir Mervyn King said in his last public appearance as Bank of England governor that world economies, the UK included, were nowhere near a normalisation of interest rates.
There is a question of whether the UK might experience de facto monetary tightening as a result of the actions in the US. Over the past month, UK 10-year gilts have seen a stronger hike in yields than that of 10-year treasuries (0.4% versus 0.32%). US 10-year yields remain marginally higher. This is a significant problem with which Carney will have to contend.
However, ultimately, monetary policy for the two countries is diverging for the first time. If the UK continues to employ QE and the US tapers, it will likely prompt a significant strengthening in the US dollar, which will in turn affect the competitive position of some US companies. Robert Royle, co-manager of the Smith & Williamson North American fund, says: “This could be a pretty big negative for US exporters in that scenario. It will be most negative for those companies that have significant international competition, such as the US semi-conductor industry. Anything that makes nuts and bolts-type products is likely to suffer.”
However, he argues that this will take time to happen and will not affect those industries with a powerful competitive position such as Boeing or some of the technology companies. Equally, he argues, many companies already have hedging in place to help them deal with just such a scenario. He adds: “The US consumer is over 70% of the economy. The goods they buy will be so much cheaper and that could help the economy get going in that way.”
The UK is likely to see less of an impact: With much of the rest of the world – and perhaps Europe most importantly – still in monetary easing mode, sterling is only likely to see any meaningful moves against the US dollar rather than any other currencies. It may improve the position of those companies that have significant exports to the US, but again, many companies hedge their exposure or report in dollars.
There are those who believe that any disparity will be relatively short-lived as the UK economy improves. Derek Mitchell, manager of the RLAM UK Mid Cap and UK Opportunities funds, says that there are signs of the beginnings of a US-like recovery taking hold in the UK: “In the UK the latest indicators point to continued steady growth in economic activity in the current quarter. Employment levels have continued to rise, albeit at a slower rate than in 2012, and the drag on overall growth from the industrial sector is starting to diminish. With the cashflow position of the household sector set to improve significantly as a result of lower taxes and lower mortgage rates, and inflation set to fall beyond the near-term, economic forecasters expect the pace of overall real GDP growth to pick up over the next 12-18 months.”
In this scenario Carney may have to contemplate his own tapering of quantitative easing, but at least the US will have been there first to show us what the effects may be.