The best laid plans of mice & men… or when QE only creates apathy
The ECB, through its president Mario Draghi, have committed to do ‘whatever it takes’ to ensure the survival of the EUR. Indeed, most of the world's central banks have now embarked on unprecedented monetary easing - through the use of formal quantitative easing in the case of the UK, US and Japan, and backdoor QE from the ECB.
However, the past few trading sessions, following on from the Fed’s QE3 and the extended QE targets in Japan, have brought apathy in place of the desired demand. This is a consequence that Japan, in the extremes of loose monetary policy for decades, knows only too well.
… and leave us nought but fear and pain for promised joy?
Initially the performance of asset prices following QE3 were as expected, or at least in line with the correlated moves following QE1 and QE2. Yet now, with 10-year US yields at pre QE3 levels and the USD and risk sentiment little altered, markets are beginning to question the efficacy of global central bank actions. If the world's monetary authorities are continuing to promise ‘whatever it takes, the question that will likely rise from here is ‘what will it take’?
Less concentrated focus of risks
A recent European fund manager poll highlighted the fact that since the ‘implied’ bond buying plan from the ECB was announced (I say implied because there is no clear sign yet that its intended recipient, Spain, wishes to take up the offer, at least while it is not forced to by the market), the biggest ‘tail risk’ for global financial markets comes from the US, in the form of the 'fiscal cliff.' Yet Europe’s woes will not be too far from the headlines for many years to come. This is a subtle but important change to the fundamental backdrop.
A winter of discontent?
Further, the statements of discontent from the emerging world over the (albeit highly flagged) initiation of the Feds endless QE3, were as loud as they were diverse. Ever lower long-end rates and cheaper borrowing promote ‘hot money’ capital flows into higher-yielding emerging markets, and the volatility can be more destabilising than beneficial. On reflection, causing any doubt over the growth of the emerging world after it has been responsible for most if not all of the total global growth over recent years is worrying in itself.
The current focus
Going into next year, the issues of social unrest and growing global tensions may likely add to the complexity of markets but for now we will focus on the present.
Indeed, undoubtedly the most immediate issue that the world and financial markets must face going forward is the global growth slowdown. Whether it is driven by austerity in the West or falling export and domestic demand in the East, it will play a dominant role in investment decisions for the rest of the year and beyond.
“Global slowdown is intensifying” BoJ Governor Shirakawa
So where does that leave the global economy and risk assets at the current juncture?
While the scepticism (and in some cases strong disquiet from emerging nations) at the recent US and Eurozone easing has given rise to some ‘risk off’ it has to be said that (discounting the much longer term implications for inflation and risks to Fed and ECB balance sheets) the risks of a disorderly negative outcome have been significantly lessened. Mario Draghi may well have given us the “effective backstop” that Spain et al. need to get their houses in order, even if this process takes longer than we would have hoped.
Two-way market for now?
Ultimately, this likely means a greater degree of volatility in smaller broad ranges, or to put it another way, there will likely be a greater divergence of opinion as to the efficacy of individual financial assets and individual currencies, but the ‘tail risk’ of a Eurozone, or indeed USD collapse, have likely been mitigated.
In currency terms, I feel that the concepts that I emphasised greatly at the start of the year, economic differentiation and relative value, are likely to become dominant. In the major FX space I remain very positive on the prospects for GBP, and while I expect two way markets to dominate the USD and the EUR from here, I don’t think EURUSD has seen its cycle highs yet (but the straight line move could well be over). AUD, as highlighted by yesterday’s IMF report and S&P warning that Australia’s AAA rating may be in danger if the AUD does not fall in line with the deterioration in its terms of trade, is overvalued and as I see things should continue to decline.
My next blog will be on Tuesday 2nd October, where I would expect things to be the same but different. Broad risk assets and economic sentiment will likely ebb and flow from here, perhaps quite sharply, but while things may not get much better for the global economy for a while, they are unlikely to get sharply worse either.