America might have killed off Quantitative Easing, says Brian Tora, but it’s only just gearing up elsewhere
This article was submitted in mid-November 2014
After a difficult early autumn, markets appear to have settled down a little and have even succeeded in making back some of the lost ground. Behind the calmer period that’s been ushered in has been the activity of central banks. Markets are increasingly dancing to the tune that these important policy makers are playing. And their role has become even more crucial, following the financial crisis of six years ago that ushered in a global recession.
A Split Decision in the US
Core to recent developments has been the decision of the Federal Bank of the United States to end the latest round of monetary easing. While this should be taken as a sign that economic activity has finally returned to normal conditions, such is the nervous state of mind of investors presently that the initial reaction was to mark equities lower. The subsequent recovery has been patchy, to say the least.
The decision to bring this latest round of quantitative easing (QE3) to a close was not unanimous. One member of the Federal Open Markets Committee (FOMC) voted against, citing sluggish economic performance and a lowering in the expectations for the inflationary outlook. And elsewhere, fears of deflation continue to exert influence on the thinking of some central bankers – although not, it seems, in Japan.
Fighting Deflation in Japan
Despite some fairly robust measures introduced to kick start the Japanese economy, there are few signs in Tokyo that QE is working in the way in which it has arguably turned the US economy around. True, the yen has depreciated, exactly as intended – but Japan’s export model does not appear to be benefiting. Domestically produced goods are priced at the higher end, notoriously insensitive to price reductions, while more mass market goods, like cars and TVs, tend to be produced abroad, closer to the consumer.
The problem seems to be more cultural than anything. Deflation has been present in Japan for so long that consumers and business leaders alike organise what they do on the assumption that it will continue. This stifles both consumer spending and business investment. While shares did initially benefit from the boost – mainly from foreign investors – that real action on the monetary easing front delivered, the failure to translate this into higher economic growth has not encouraged further buyers of equities.
Of course, the progressive doubling of sales taxes has not helped confidence. (From 5% to 8% last April, and onward to 10% next October.) The corollary of that was meant to be a reduction in corporation tax – Japan has one of the highest rates here in the developed world – but so far this hasn’t happened. Moreover, higher wages, which have been expected as part of the plan to introduce Western style inflation, have not yet materialised. With a weaker yen, households are finding themselves squeezed as a result.
Over To You, Europe…
But with the US turning off the liquidity tap (at least for the time being), it will fall to Japan and the European Central Bank to pick up the baton. While the ECB does seem to be joining in with the money printing exercise, as in Japan there is little sign that it is having the desired effect. The irony is that the UK, where QE also appears to have achieved results, looks like having to stump up serious cash to help bail out underperforming economies across the channel.
What does all this mean for investors? First and most obvious, it seems inevitable that interest rates will remain lower for longer. Indeed, the Governor of the Fed, Janet Yellen, said as much when issuing the statement that accompanied the ending of QE3.
This in turn means that government bonds are probably less vulnerable than previously thought – not necessarily a good thing as it provides an alternative to risk assets. For equities, the period of nervousness looks set to continue – at least until the outlook for global economic growth appears more assured or central bankers take even more drastic action.
Brian Tora is an associate with investment managers, JM Finn & Co