Monthly Archives: March 2017

One of the most dramatic monetary interventions in recent years has been the unprecedented surge in global central bank balance sheets. This form of “money printing” has not had the inflationary effect predicted by pessimists, but there is still deep unease among some central bankers about whether these bloated balance sheets should be accepted as part of the “new normal”. There are concerns that ultra large balance sheets carry with them long term risks of inflation, and financial market distortions.

In recent weeks, there have been debates within the FOMC and the ECB Governing Council about balance sheet strategy, and it is likely that there will be important new announcements from both these central banks before the end of 2017. Meanwhile, the PBOC balance sheet has been drifting downwards because of the large scale currency intervention that has been needed to prevent a rapid devaluation in the renminbi. Only the Bank of Japan seems likely to persist with policies that will extend the balance sheet markedly further after 2017.

Globally, the persistent increase in the scale of quantitative easing is therefore likely to come to an end in 2017, and it is probable that central bank balance sheets will shrink thereafter, assuming the world economy continues to behave satisfactorily.

Investors have become accustomed to the benefits of “QE infinity” on asset prices, and are cynical about the ability and desire of central bankers ever to return their balance sheets to “normal”. They will have to adjust to a new reality fairly soon. Read more

The global economic recovery that started amid the gloom of the financial crash in March 2009 is about to celebrate its 8th birthday. In the advanced economies (AEs), the GDP growth rate during this recovery has averaged only 1.8 per cent, well below normal, but unemployment has dropped from 8.1 per cent to a still fairly high 6.1 per cent. According to JP Morgan, the volatility of GDP growth has fallen to the lowest levels for four decades since 2014.

This slow but extremely steady period of expansion has of course been accompanied by much lower interest rates, which have proven terrific for asset prices. The index of total equity returns in the AEs has tripled since the bear market ended.

Janet Yellen and other officials at the Federal Reserve have said on many occasions that “recoveries don’t just die of old age”. Unless something goes wrong, the upswing in the cycle will be prone to continue. At present, econometric models that attempt to assess recession risks suggest that these risks are exceptionally low over the next 12 months.

Furthermore, the growth rate in the US and other AEs seems, if anything, to be breaking upwards. This may be because the headwinds that have held growth down for so long – excessive debt, a malfunctioning banking system, extreme risk aversion, low capital investment etc. – may finally be fading away. Perhaps the world economy is at last attaining escape velocity.

However, good times cannot last forever. It is common for euphoria to set in just when the economic and financial cycle is nearing a peak. As in 2001 and 2008, the end could come much sooner than anyone predicts [1]Read more

The robust US employment data last Friday have left almost no room for doubt that the Federal Open Market Committee will raise short term rates by 25 basis points on 15 March, and will probably warn of two or three more hikes to come this year.

Analysts seem confident that this accelerated phase of Fed tightening will involve a further rise in bond yields and the dollar, and many active fund managers are positioned for both these events to occur in coming months. Other analysts believe that the more hawkish Fed will puncture the “euphoria” in the US equity market before too long. Read more

US monetary policy has now clearly embarked on an important new phase. For a long while, the markets have been extremely reluctant to recognise that the Federal Reserve might actually mean what it says about increasing short term interest rates by 0.25 per cent on three separate occasions this year. Remembering repeated episodes in which the Fed has failed to deliver its threatened tightening in policy since 2013, investors have concluded that dovish surprises from the Fed are endemic.

Last week, however, they woke up to the fact that FOMC really is serious about raising rates in March, and that this may be the first of three or even four rate hikes this year. After a series of hawkish speeches by several FOMC heavyweights, the coup de grâce came on Friday, when Janet Yellen warned that a rate rise in March “would be appropriate” unless economic data surprised in the meantime. She added rather ominously that policy accommodation would be removed more rapidly this year than in 2015 and 2016.

The great unknown is whether this will come as a major shock to the financial markets. It will certainly mean that investors will need to build in a faster path for rate hikes in the near term than anything that has previously been contemplated in this cycle. But the good news is that the final destination for rates does not seem to be changing, at least in the view of the FOMC. The Committee is increasing the speed of travel towards its destination, but is not changing the destination itself.

So what has justified the shift toward more hawkish thinking on the FOMC? And will this upset the equity market, which is still ignoring the prospect of higher rates? Read more