4th November 2014
The US Federal Reserve may be bringing an end to its quantitative easing programme, but the European Central Bank and Bank of Japan are likely to continue to increase the scale of the global monetary stimulus, experts predict.
“Back in 2009, talk that the Federal Reserve would need to carry out $5 trillion of quantitative easing (QE) was considered as wild speculation, ” said Jeff Keen, head of asset allocation at Waverton Investment Management.
“Now Central Banks globally have expanded their balance sheets by $16 trillion. Even with the US Federal Reserve announcing the end of QE (except for the reinvestment of coupons), new announcements from the ECB and the Bank of Japan suggest that the overall figure will continue to rise,” he added.
Keen said that while these policies extend the period during which financial markets are distorted by the interventions, they do underline the commitment of central banks to preventing deflation and will help to boost confidence in the global economic recovery.
He said that the increase in stimulus announced by the Bank of Japan last week, the pressure will be on the ECB to ensure that deflation does not take hold in Europe and the very low level of inflation expectations gives ECB president Mario Draghi the mandate to move more aggressively.
Keen said that global financial markets may be underplaying the potential for interest rate rises in the US.
“Financial markets continue to project a much shallower path for US interest rates than that indicated by the Federal Reserve,” he said.
“We think this is symptomatic of a general complacency towards the potential for higher rates over time. In our view, just a slightly more optimistic view of the global economy, or perhaps less focus on deflation risk, could lead to a much higher level of expectations for interest rates across the developed world.”
As far as investors are concerned, this would represent a major headwind for the fixed income asset class, Keen warned, and therefore Waverton recommend a highly strategic approach to this part of clients’ portfolios.
“The macro-economic environment is a complex one but we remain biased towards risk assets,” said Keen.
Russ Koesterich, global chief investment strategist at BlackRock, also warned that signs of the US’s strengthening recovery point to rate rises next year.
He said: “As expected, the Federal Reserve completed its QE program last week when it wound down its program of extraordinary bond purchases. The Fed also indicated that it believes the labour market has made substantial improvement and that the recent low inflation readings are transitory (mostly a function of lower energy prices).
“All of this suggests that the Fed is still likely to begin raising rates next year, probably over the summer. The somewhat more hawkish tone from the Fed had the predictable impact of pushing the dollar higher and gold, which has fallen below $1,200 per ounce, lower.”
But he said that the recent strength in the dollar is not simply a function of a relatively strong US economy, but the relative weakness evident in the rest of the world. With the economies in Japan and Europe struggling, their central banks are being forced to ease monetary policy at the same time the Fed needs to start contemplating raising US rates.
Koesterich said: “This dynamic was on display again last week as the Bank of Japan (BoJ) unexpectedly expanded its own version of quantitative easing. ”
He added: “For now, we continue to expect a world in which US growth overshadows that of other developed countries, resulting in a strong dollar and weaker commodity prices. However, this situation could lead to extraordinary stimulus measures by other central banks which, in turn, could benefit their stock markets.
“Accordingly, we remain constructive on Japanese stocks, which should continue to enjoy the tailwind of aggressive monetary policy by Japan’s central bank, much as the US has had from the Fed over the past several years.”