Article / 22 July 2016 at 16:00 GMT

Monetary accommodation is still trump

Head of Trading / The ECU Group plc
United Kingdom

  • Monetary accommodation is still "trump" in today's macroeconomic environment
  • Concept of concerted monetary and fiscal stimulus increasingly mooted
  • Expectations are growing for further BoJ accommodation
  • BoE may feel need to support sentiment by turning QE taps back on
  • Equities and risk assets have probably run too far as yields have dropped
  • We retain a bullish macroeconomic outlook relative to broad market expectations

Bank of England

The Bank of England, where policycmakers meet on August 4, could be about 

to embark on further easing. Photo: iStock 

By Neil Staines

“Whatever interpretation prevails at a given time is a function of power, not truth” — Friedrich Nietzsche

In the financial market's current game of "Top Trumps", monetary accommodation trumps geopolitical concerns, overvaluation, and just about any other macroeconomic argument you could put forward. Furthermore, the idea of concerted monetary and fiscal policies is increasingly being aired. 

In terms of equities and risk assets, we continue to feel that this relationship has gone too far. For example, US earnings have declined for seven straight quarters against a global backdrop of rising geopolitical and macroeconomic uncertainties. Yet, a falling yield curve, underpinned by expectations of  (relative) monetary accommodation, has produced record highs in a number of major indices this month. 

In forex, however, we expect monetary and — increasingly, at this late stage of the easing cycle — fiscal policies to continue to dominate, relative to both expectations and other market forces.

Indeed, as monetary policy reaches the point of diminishing returns, the concept of concerted monetary and fiscal stimulus (or even monetary financing of fiscal stimulus, or "helicopter money") has been increasingly mooted. It is unclear whether such monetary and fiscal activism will achieve the aims of boosting growth and inflation (at least directly). However, under such circumstances, a country’s currency is likely to underperform, potentially significantly.

“The big print giveth and the small print taketh away” — Tom Waits

Just after the release of UK data yesterday morning, an interview with the Bank of Japan governor Hirohiko Kuroda was aired (subsequently said to have been recorded in June), in which he said that there is “no need and no possibility for helicopter money”.

Tokyo street

Busy Tokyo street. The yen failed to ease much despite reports of mega-sized 
stimulus to come. Photo: iStock  

However, the Nikkei news service this week flagged its expectation of imminent (and extraordinarily large) fiscal stimulus, likely for early August. Having gone from an estimated ¥10 trillion at the start of the week, to ¥20 trillion mid-week, overnight the news service said that it might be as much as ¥30 trillion, more than 5% of GDP. At the same time, expectations are growing for further accommodation from the Bank of Japan, through the expansion of its (already huge)  quantitative and qualitative programme.

In the UK, the very disappointing PMI data this morning (service sector activity falling back to its lowest level since 2009) exacerbated expectations of further monetary easing. The interest rate markets are now almost fully pricing a 25-basis-point rate cut in August (with ~85% likelihood). 

We expect the Bank of England will feel the need to support sentiment and, where possible, consumer and business spending, and that the best way to achieve this is likely by turning the quantitative easing taps back on, in the hopes of boosting asset prices. The BoE policy meeting announcement on August 4 is now the ultimate focus.

If, as has already been alluded to by Britain's new prime minister (and her new next-door neighbour), the fiscal stance is also loosened by reduced austerity (or a “reset of fiscal policy” as the chancellor referred to it last night), it may be difficult to argue convincingly that a monetary-financed fiscal expansion is not occurring in the UK. 

Technicalities, such as the permanence of the monetisation and the extent of government involvement, remain moot (as well as the real difference between government purchases of bonds in the secondary market). But it could be argued that helicopter money is already here, in the UK and in Japan. It likely boils down to your interpretation.

Stability not pandamonium

The European Central Bank policy announcement and press conference on Thursday was relatively uneventful. In the Q&A session, however, ECB president Mario Draghi was asked “What is the message of Europe and the ECB to the G20 this weekend?” 

Draghi's response summed up the mood and message of the whole news conference: “It would be a message of stability. A message of a [EZ] recovery that continues, though at a slower pace, amid great uncertainties.” He went on to say that “those uncertainties were not especially from the Eurozone, but various parts of the world and, in this climate of … geopolitical uncertainty, it is very important that the G20 portray a message of stability.” 

ECB president Mario Draghi

 The ECB president said his message was a "message of stability". 
Photo: screengrab from ECB webcast news conference July 22

During, and indeed after the ECB formalities, the euro was duly stable. In our view, however, as cyclical growth momentum slows from the first quarter to the second (and likely H1 to H2), without any structural assistance from national governments, the Eurozone and indeed the euro will become increasingly fragile.

“You may delay, but time will not” — Benjamin Franklin

While we see further (perhaps substantial) monetary easing over coming weeks (BoJ on July 29, BoE on August 4), we retain a bullish macroeconomic outlook relative to broad market expectations.

Although we are increasingly cautious on equities and risk-asset levels (despite, and also as a function of their relentless rise on ever-further global monetary and fiscal indebtedness), we are relatively hawkish on the prospects of US growth and interest-rate rises, which would likely be negative for equities, if our views are correct. 

Most notably, however, while we are increasingly think the UK is about to embark on monetary easing (likely a combination of a rate cut and further QE), we retain a positive bias towards medium-term UK growth prospects.

Indeed, once GBP has adjusted (lower, if we are right in our expectations) to the reality of looser monetary and fiscal policy, we are increasingly enthusiastic about the prospect of buying in FX markets, most notably versus the euro.

— Edited by D. Deacon and John Acher

Neil Staines is head of trading at The ECU Group

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