The age of easy money is being hailed as over. But has the ‘great unwind’ really begun?
Investors are taking the withdrawal of policy accommodation in their stride
Last Friday morning, the lead article on the website of Bloomberg was entitled, “The age of easy money is nearly over”.
This is the latest in a plethora of articles and opinion pieces in the financial press over the past several months heralding the shift in monetary policy as leading central banks, led by the US Federal Reserve, start to scale back their quantitative easing (QE) programmes and raise interest rates.
Both Financial Times and The Wall Street Journal recently screamed headlines “Era of quantitative easing is drawing to a close” and “Markets braced for Fed’s unwinding of easy money”.
Yet has the “great unwind”, as the withdrawal of stimulus is being dubbed, really begun and, if so, are the financial markets – which have benefited immensely from QE as asset prices in both developed and developing economies have surged and measures of volatility have collapsed – really showing any signs of nervousness?
The answer to the first question is not as clear-cut as it might appear.
On the face of it, the retreat from ultra-loose monetary policies started in May 2013 when the Fed unexpectedly announced it would begin winding down its asset purchases, triggering a sharp sell-off known as the “taper tantrum”.
Since then, the Fed has raised rates several times and has just started to pare back its US$4.5 trillion balance sheet. The European Central Bank, meanwhile, announced last month it will halve its purchases of bonds in January while the Bank of Canada and the Bank of England have joined the Fed in increasing rates.
Clearly, there has been a significant shift towards policy normalisation and not just on the part of the Fed.
Yet there is a world of a difference between an aggressive and coordinated tightening in global monetary policy and a cautious and gradual withdrawal of stimulus that still leaves policy extremely accommodative by historical standards.
Even though the Fed has lifted rates four times since December 2015 – and will almost certainly increase them once more next month – its rate-hiking cycle still amounts to, as Mohamed El-Erian, a veteran bond investor, rightly observes, “the loosest tightening [of policy] in its history”.
The impact of the Fed’s rate rises is also being mitigated by the aggressive bond-buying programmes of the Bank of Japan and the European Central Bank.
Not only is the Bank of Japan continuing to buy assets at a pace of 80 trillion yen a year – a new board member of the central bank is even calling for additional stimulus – the ECB has prolonged its QE programme until at least September 2018 and is reserving the right to buy more assets if the euro-zone economy takes a turn for the worse.
Make no mistake, stimulus would have to be removed at a much faster pace before it begins to eat into the expansionary policies of the world’s leading central banks.
This is mainly because global inflation rates remain worryingly subdued despite a pickup in growth. Even the Fed’s preferred measure of inflation still stands at just 1.3 per cent, significantly below its 2 per cent target, while core inflation – which strips out volatile food and energy prices – in the euro zone and Japan is less than half the central banks’ target.
This is one of the reasons why investors have taken the withdrawal of policy accommodation in their stride. The benchmark 10-year Treasury yield currently stands at just 2.3 per cent – a mere 60 basis points above its level just before the taper tantrum – as markets price in little growth and inflation in the coming years. According to JP Morgan, 20 per cent of the global stock of sovereign debt is still negative yielding.
Another reason markets have remained remarkably calm in the face of the hawkish tilt in monetary policy is because central banks are conspicuously reluctant to remove stimulus more aggressively – partly because of concerns about endangering the recovery but also, just as importantly, because of their fear of unsettling markets.
Last week, the Bank of England raised rates for the first time in a decade despite a slowing economy and mounting uncertainty about Britain’s fraught negotiations with the European Union over the Britain’s departure from the bloc. So convinced were investors that the Bank of England itself questioned the merits of the jump that the pound even fell 1.4 per cent against the US dollar on Thursday – precisely the opposite reaction sought by the central bank as is seeks to dampen inflation.
For markets, the shift in monetary policy is occurring not with a bang but a whimper. The “great unwind” has barely begun.
Nicholas Spiro is a partner at Lauressa Advisory