Accommodative monetary policy and prospects for equities
Extraordinarily accommodative monetary policies undertaken by the major central banks have led to astounding strength in financial asset markets, despite an uneven global growth backdrop. The International Monetary Fund (IMF), in their latest World Econo
Despite aggressive policy easing, growth in advanced economies is reasonably sluggish on a historic comparison, while inflation remains below medium-term targets. The unprecedented level of liquidity resulting from market intervention has, however, found its way into asset markets, with the likes of the developed world stock and bond markets reporting record highs.
Complacency in risk assets remains at extremes, with investor sentiment, while rolling over in some measures, remaining relatively elevated. The Chicago Board Options Exchange Market Volatility Index - or fear gauge, as it is commonly referred to - is currently tracking at pre-crisis lows, suggesting little anxiety, despite continued political and financial risks still lingering in the system.
With fears around a sharper-than-expected reduction in quantitative easing (QE) partially triggering the largest two-day fall in the gold price in 30 years, the dampening effect of fiscal tightening on US growth could ease concerns around an earlier withdrawal of QE. The adverse impact of sequestration cuts (mandatory across-the-board federal cutbacks) has recently seen a reversal in economic surprise indices, which is likely to lead to receding risks of the Federal Reserve (Fed) scaling back on its securities purchases, currently comprising USD40 billion and USD45 billion a month of mortgage-backed and Treasury securities respectively. While the current debate is focused on the process and timing of the phasing out quantitative easing, the Fed has reiterated that purchases will continue until the outlook for the labour market had improved “substantially”. Members have also, more recently, noted the importance of a broader assessment of labour market indicators.
Nearly half of the equity markets in the G20 economies – which account for c.80% of the world’s GDP – are up in local currency terms on a year-to-date basis, with gains led by Japan’s Nikkei, the S&P 500 in the US, Australia’s ASX200 and the FTSE in Britain. Over the same period, the CAC40 in France and DAX in Germany have largely tracked sideways and, more recently, lost ground. While the recent Cypriot bailout debacle has emphasised the lack of appetite for Japan or US-style easing in the Eurozone, worsening economic sentiment and the potential for a resurgence in political risk caused by Italian and German elections later this year has roused speculation of further easing by the European Central Bank.
In the current yield-starved environment, on-going flows into emerging market (EM) debt funds have continued, while softer data in the US and disappointing growth numbers out of China have led to further broad-based weakness in commodity markets, sending a cautious signal on domestic equity market performance as outflows among EM equity funds broadened.
Over the longer-term horizon, disorderly exit from current monetary stimulus remains a key risk threatening financial stability and growth. The wall of liquidity shifting to EMs in search of higher returns in asset prices has raised fears of asset price bubbles fuelled by a rapid rise in cheap credit and loose financial conditions, challenging policy-makers in these economies.
