Opinion: Normalising monetary policy could be a major car crash for investors
Day of reckoning is fast approaching, especially for global stock investors pumping new money into European equity funds, ramped up by the spectacle of Germany’s economic ‘miracle’
Global investors have been jumping through hoops in recent years, many of them ringed with fire.
Even though markets have had to run the gauntlet of some very serious risk events, investor confidence has transcended the worst thrown at it. To prove it, stock market indices are running at all-time highs.
The global financial crisis has been and gone, Europe has survived intact and global policymakers seem cautiously optimistic that the world economy is back on the mend. Global trade flows are bouncing back. So what is there to beef about?
If stock markets start banging up against future reality checks, there may be a good reason for it. The mother of all risk factors, which still needs to be bridged, is the future return to “normal” monetary policy. The global economy has been living in a dream world of cheap and easy money for far too long.
The world has much to be grateful for the major central banks pulling out the stops to get global recovery jump-started after the 2008 crash.
Zero interest rates and a massive glut of quantitative easing (QE) did a fine job cranking up economic revival, but too much of a good thing also causes problems. When the world starts running on empty is when investors should begin to worry.
With global investors so pumped up on the “great reflation trade”, it seems an act of heresy to think anything otherwise right now. After all, Japan is still in the thick of monetary la-la-land, battling hard against decades of economic stagnation and deflation. And Europe still seems committed to extending QE stimulus at least until the end of the year.
But the winds of change are starting to shift. In the United States, key monetary officials are already lifting the ante on trimming the Federal Reserve’s balance sheet, perhaps starting as early as this year.
This means QE will soon be going into reverse in the US, but at least the Fed is going about it in the right way, spreading the word gently so it will not come as too much of a shock to investors. Well, that is the theory.
Where a potential shock awaits investors lurks in Europe. It would be a fine thing if the consensus in the European Central Bank over extended QE was unanimous. But right now, divisions are opening up and they are likely to become a lot more bitter, especially as Germany baulks at getting too much of a good thing from the ECB’s over-loose policies.
Germany knows full well that access to negative interest rates and boatloads of easy QE cash, bolstered by a cheap currency, has done wonders for its economy. But its lift-off is now bordering on economic excess.
The latest numbers show Germany is flying. Growth is rattling along at a 2.5 per cent rate. Companies are investing more, consumers are on a spending spree and exports are surging. Forward leading indicators like Ifo’s business climate index are close to all-time cyclical highs, but problems are mounting, too.
Strong growth may be good news for German Chancellor Angela Merkel, seeking a fourth term in office in national elections on September 24, but the surfeit of good news is ringing alarm bells at the Bundesbank, Germany’s conservative-leaning central bank, a well-known inflation hawk.
Thanks to the ECB’s super-stimulus, Germany’s growth rate is being over-egged. Domestic demand is too strong and labour demand running too close to full employment, leaving underlying inflation pressures a potent threat. The Bundesbank would much prefer to be proactive and nip these pressures in the bud rather than leave it too late.
It suggests closing down QE and shutting off negative interest rates as soon as possible. It also means a row will be brewing between Germany and its less fortunate euro-zone partners, which seem much more dependent on monetary policy staying in perpetual overload mode.
A day of reckoning is fast approaching, especially for global stock investors pumping copious amounts of new money into European equity funds, ramped up by the spectacle of Germany’s economic “miracle”.
If Germany gets its way and the monetary taps are turned off early, the big issue is whether Europe’s recovery can stand on its own two feet or trip over. Without being pumped full of monetary steroids, the danger is the euro zone is still a zombie economy.
Equity markets could be in for a very bad shock. Normalising monetary policy threatens a major car crash for investors.
David Brown is chief executive of New View Economics