QE: The Beginning of the End

Printing Money

To limit the damage from the financial crisis, central bankers were forced into Quantitative Easing (QE) on a massive scale, in possibly the largest ever monetary policy experiment. The policy worked and confidence returned to financial markets. Nearly a decade on from those events, are we now looking at the end to QE and the ‘lower for longer’ mantra on the level of interest rates?

More recently, we’ve read an increasing number of ‘hawkish’ (or ‘less dovish’) statements from central bankers in the UK, Europe and US.

Now markets are starting to consider the possibility of a new approach, as evidenced by Citi’s forward forecast of Central Bank purchases over the next 12 months, compared to the history since 2009 (see chart below).

What’s changed?

So what has changed, you may ask?  Inflation is undoubtedly on the rise, driven partially by the increase in commodity prices last year, but wage expectations are also gradually starting to rise and in the UK many firms are battling high import costs driven by the significant fall in Sterling since the Brexit vote.

Generally speaking, economies also appear to be in pretty good shape, with the UK and the US continuing to post solid, albeit not spectacular growth and employment, while Europe, in particular, appears to be in the midst of a more rapid recovery.

Side effects of QE

There are also the unintended side effects of Quantitative Easing to consider.  Whilst many of its precise impacts are still unclear, academics and market commentators are increasingly coming to the conclusion that the quick action of central bankers prevented the mass unemployment (particularly among younger and low-income workers) that scarred the 1930’s after the banking collapse at the start of the Great Depression. Instead, companies have retained workers and reduced capacity, but wages and productivity have stagnated for almost a decade, despite many economies apparently operating at full employment.

Intergenerational fairness

QE massively inflated asset prices, in property, bonds and equities; assets typically held by the wealthy, by pensioners and by higher earners.  At the same time, the younger generation and those dependent on fixed incomes, have faced freezes on real income, job displacement from technology and globalisation and, for UK students, a massive increase in tuition fees and debt.

These dynamics appear to be brewing a political storm, as we saw from the increase in younger voters supporting Jeremy Corbyn in the last General Election.  Governments and central bankers are therefore facing increasing pressure to consider whether their ‘extreme’ and ‘experimental’ measures are really still necessary today.

What next for markets?

So what does this mean for asset prices?  If, after a decade of cheap money, policy becomes more restrictive whilst economies are recovering strongly, and wages are increasing, and companies generally appear to be in pretty robust shape, then it will be back to a stock selection paradigm. Good companies will do well, weaker companies will fade.  If however, policy assistance is removed, just as growth is beginning to slow, then there is a real risk that policy error might induce a recession, a nightmare which keeps all central bankers awake at night.

The response so far has been to move very gradually with plenty of forward guidance to markets, a strategy which appears to have been relatively successful in the US but requires a very careful balancing act to ensure expectations around inflation targets are carefully managed and central banks are not seen to have significantly missed their targets.

At Parmenion, we continue to monitor the situation very closely and ensure our portfolios are very broadly diversified across all sub asset groups and fund manager styles. We continue to favour those managers who offer consistently attractive risk adjusted returns and a strong focus in their process on the potential for capital loss.

 


The above article was first published by Parmenion on 23rd August 2017