Japanese interest rates are negative, Euro-area rates are still at zero, the UK official short-rate is at 0.75% and in the US at 2.25%. The Japanese are still running a quantitative easing programme, printing money to buy up state debt, and the Euro-area is doing a little bit more of the same until the end of this year. Well into the recovery of the advanced economies from the banking crashes of 2008-9 you might think this was still easy money supporting fast growth. Many in the markets now fear otherwise. Whilst rates remain low, all the talk is of rates rising a bit more. Whilst there is still residual money printing in the Euro-area and some continuing in Japan, the bonanza for markets from the large quantitative easing programmes of the past is behind us. There is a worry that central banks may tighten too much, slowing the recovery or aborting it in the slower growing places.
The annual growth of money has fallen in the US to just 3.5% (using money supply figure “M2” which includes cash, current account, savings and mutual funds, amongst others) on the latest figures. The UK money growth rate has halved to 2.5% (using “M4” in September, a broader measure of money supply that excludes financial corporates). The European Central Bank is about to end its additional bond buying, and even Japan has been buying a bit less and talking about less stimulus. They too may report slower money growth. The Japanese are also preparing for a sales tax increase next year. The last time they did this it damaged demand once it was introduced, with some pre-emptive buying before imposition. Decent growth rates require optimism by consumers and companies, prepared to borrow to buy the bigger items like cars and homes, and to spend on investment in new products and additional capacity. Confidence is a precious flower which needs tending by the authorities. They need to be careful not to squash such a hard won and slow recovery, whilst remaining vigilant about inflation.
If we look at past crises that have taken markets down sharply they usually have a credit and banking problem attached to them. The oil crisis recession of the 1970s saw money tightening as well as a big oil price rise, as perceived excesses of credit were reined in. In the UK, there was a property decline with many commercial property companies revealing a lack of sustainable income to pay all their borrowings easily. The Exchange Rate Mechanism crisis of the early 1990s saw the countries that struggled to keep their currency up with the rising value of the German deutschemark having to place a tough monetary tightening onto their economies. As the pound fell, for example, the UK had to raise interest rates to seek to dissuade sellers of the currency. It ultimately proved self-defeating when the interest rates were so high it caused a recession, undermining confidence more. The great recession of 2008-9 was first and foremost a banking crash. Over optimism by commercial banks along with tolerance of more risk by central banks was followed by a sharp restriction on credit which pushed many large banks into financial trouble. As central banks tightened, the commercial banks could not lend more, which led to a plunge in economic activity.
We continue to think the central banks this time round should avoid aggressive measures that could bring economies down and undermine asset values on the scale of these past crises. We hope they have learned from the bitter experiences of the past, where undue laxity was followed by damaging and excessive tightening. There is a growing gap between what markets think the Fed can do by way of interest rate rises and what the Fed suggests it may do. There is growing evidence that even small steps towards higher rates elsewhere has an adverse impact on activity. Central banks need to recognise that just ending all quantitative easing, as all but Japan are doing, is a big step in itself. We think the world should muddle through with growth continuing next year, but as we have been warning, it is likely to be slower. This is the background against which bearish stories circulate and affect share prices. This week stress in the technology industry and allegations about poor standards of corporate reporting in Japan have been enough to take prices down again.
The above article was previously published by Charles Stanley on 20th November 2018