Clock’s ticking for tighter money in the US, Britain and Europe
Time’s being called on super-stimulus, with policy normalisation now the way forward
There comes a time when you can have too much of a good thing and the US Federal Reserve is finally putting markets on notice that the era of cheap money is at an end.
And it is not just America that is calling time on super-stimulus.
If global investors read the runes correctly, the clock is ticking for tighter money in Britain and Europe, too.
Last week’s quarter-point rate rise by the Fed was another warning the party is over for cheap and easy money and policy normalisation is the way forward. If markets choose to ignore the advice, they only have themselves to blame.
Global recovery has a much better footing, job growth looks more secure and world markets are having too much of a good thing in terms of perpetual rally. Central bankers are never the ones to hand out too much free spirit, especially when the party seems to be getting out of hand. So it is raising the risks of a bigger market correction coming soon.
In recent years, global investors have been showing a bit too much zeal. It has raised concerns in central bank circles that zero interest rates and over-generous liquidity might have won the battle for global recovery but scored an own goal by encouraging excessive speculation and irrational exuberance.
Wealth creation for the fast-money, heavily leveraged speculators, investors and hedge funds might have benefited a small minority but has not been in the best interest of generating self-sustaining global recovery and job creation for the vast majority.
There is a strong case that central banks have ended up too far behind the curve for prudential demand management and responsible inflation control.
The Fed has wised up to the pitfalls and is pulling the chocks away to higher rates ahead while putting markets on notice that it will be winding down its US$4.2 billion stockpile of assets built up during its quantitative easing programme. This could be the game changer for investors.
US gross domestic product growth running at 2.5 to 3 per cent, with the economy running close to full employment, definitely warrants the shift to tighter policy. Just because US inflation has failed to show up in force so far is no argument that it will stay muted in future and that the Fed should back off.
Proactive, prescriptive monetary policy is about carefully managing expectations. At present levels, US monetary policy is still far too expansionary – with or without President Donald Trump’s “Promised Land” claims of “America First” and surrounding hype about doubling the US growth rate. It needs reining in.
The US is not alone. Last week’s Bank of England meeting was a clear-cut signal that British rates would be on the rise fairly soon. The so-called “Hawk Shock” of the monetary policy committee’s 5-3 split in favour of keeping policy steady should have been no surprise, especially with British inflation surging to a four-year high of 2.9 per cent last month. Britain is due for a change, too.
The balance of British macro policy is out of kilter. Cheap money is boosting the country’s equity markets to all-time highs while fiscal cutbacks are hitting its social fabric extremely hard. So it is no surprise British voters are turning against the austerity-minded Conservative government in droves. Higher British rates will probably need to be a corollary to higher public spending on education, health, housing and social care.
In the euro zone, markets are on notice that interest rate cuts are at an end and that the European Central Bank’s quantitative easing programme of asset purchases will probably dry up at the end of the year. Anything more on the super-stimulus stakes is highly unlikely, being deemed dangerous overkill by Germany’s super-vigilant central bank, the Bundesbank.
It looks like global monetary policy is heading for a major reboot. The consequences will be that short-term interest rates and long-term bond yields are heading higher, something that will make global equity and risk asset markets squirm. Real interest rates have been in negative territory for far too long, an anathema for healthy economies in the long run.
This artificial suppression of real rates and yields might have fostered better global recovery and stronger financial markets but it has been at the expense of better returns for savers and pensioners.
There is a paradigm shift coming and the markets had better be prepared for some big changes ahead.
David Brown is chief executive of New View Economics