Four reasons quantitative easing is not the solution to the global economy’s problems right now
- The damaging effects of the previous rounds of quantitative easing are still being felt in low bond yields, falls in European and US bank shares and increased income inequality
- Further monetary policy loosening might convince investors a recession is imminent while a market rally could encourage Trump in his trade war
One of the reasons why financial markets had such an abysmal 2018 was the fear among investors that quantitative easing – the extra cash pumped into the financial system by the world’s leading central banks to cope with the fallout from the global financial crisis – was giving way to quantitative tightening.
To be sure, the outbreak of dovishness is not without foundation. In the euro zone, a closely watched market measure of inflation has fallen to below 1.2 per cent, down from 1.7 per cent for much of last year, fuelling concerns that inflation expectations are becoming “deanchored”.
Even in the US, whose economy is still relatively buoyant, growth is weakening. A gauge of manufacturing activity fell to its lowest level last month since October 2016, while employment gains slowed sharply, heaping pressure on the Fed to deliver an “insurance” rate cut to sustain America’s economic expansion.
Yet while the threat of a protracted US-China trade war is exacerbating the global economic slowdown, the case for a dramatic loosening in monetary policy is a tenuous one, to say the least. A calibrated easing is one thing; another round of quantitative easing is quite another.
Investors are no longer differentiating sufficiently between good and bad borrowers. The further yields fall – the benchmark 10-year US Treasury yield has already fallen nearly 50 basis points since mid-April – the more distorted asset prices become.
Second, ultra-low rates – which are below zero in the case of Japan and the euro zone – have eroded the profitability of banks whose net interest margins have shrunk significantly, particularly in Europe. The prospect of looser monetary policy has led to sharp falls in European and American bank shares over the past month.
The last thing the global economy needs right now is increasing market anxiety about a sharper downturn in the US, the one major economy which, for the time being, is still performing relatively well. Investors should be careful what they wish for, while the Fed needs to be ultra-careful not to miscommunicate its policies.
When the Fed holds its rate-setting meeting next week, it will be acutely aware of the risks involved in turning on the monetary spigot once again. With some investors expecting as many as four rate cuts this year, the Fed has a duty to explain to markets why looser policy could end up doing more harm than good.
Nicholas Spiro is a partner at Lauressa Advisory