Op-ed: Quantitative Easing in the US, UK and Euro-Zone – The Response of the Central Banks
May 21, 2014 12:05 pm
European equity markets are mostly mixed, flipping between small gains and losses with market participants contending with the prospect of the European Central Bank underwhelming the market with a lighter stimulus package than anticipated.
At the same time, the bullish momentum in markets is fading somewhat as benchmark indices in major developed economies like the US and Europe are in the sixth year of a bull market. Indeed, some are calling for a correction which is a demonstration of health in cyclical markets in which fundamentals strongly support an uptick in the wider economy. That’s at least the case for US stocks where the S&P500 and DJIA are both trading at record all-time highs.
The attention in the US will be on the meeting minutes from the Federal Reserve policy-makers for the April 29-30 meeting. The Fed’s commentary to markets thus far in 2014 has consisted of doveish rhetoric mixed with hawkish action – commitment to low rates but a reduction of quantitative easing – a welcome response in the eyes of the market, which is well aware that open ended liquidity needs to come to an end or else central bank balance sheets are operating beyond their means.
That said, many in the market are still not entirely prepared for the first interest rate rise, which is expected this time next year despite efforts by the Fed to stay tight lipped on the matter. Fed members, however, including Janet Yellen, believe the pace of growth in the US is not at the levels they would like it to be at, thus low rates will stick around for now. Interestingly, the reaction in bond markets is in contrast to what many have expected – equities and bonds traditionally work inversely, with investors adjusting allocations to reflect macroeconomic performance and valuation/yields presented by both asset classes. One would have thought this would be the year of for equities to continue to outperform prompting an exodus out of bonds. That hasn’t been the case, with yield hunters still investing in bonds, particularly US Treasuries on the back of the favourable returns still offered due to the conflicted yet friendly rhetoric by the Fed.
It’s certainly all about central banks this month, as it has been really for the past five years, but the focus now is firmly on the ECB who have been said to be behind the curve versus other major central banks in the stimulus game. Low-inflation and a stronger euro currency raise the spectre of disinflation in the euro area, threatening to derail a fragile and vulnerable economic recovery just after the euro zone puts the debt crisis behind itself. Rate cuts and LTROs over the past five years have helped to shore up money markets but many do not believe policy action thus far from the central bank has filtered into real GDP for many economies.
At the last policy meeting, strong suggestions by the ECB that it will consider all options to tackle the disinflationary threat and prop up the euro zone economy inspired investors who have long awaited for a gung-ho response by the central bank. Hope – if not belief – of a forthcoming package including rate cuts, negative deposit rate and a Fed/BOE/BOJ style quantitative easing/bond buying programme, helped euro zone risk assets and stunned the rise of the euro currency which had worried many nations and corporations which have seen an unfavourable FX impact on a strong euro.
Meanwhile, it’s a different tale at the Bank of England – the central bank has to get to grips with an improving economy which prompts rate increases as early as next year, but MPC members seem to be buying their time before such action can be taken, adopting dovish stances whilst wearing hawkish masks. Minutes from the last meeting by the BOE suggested the policy debate between MPC members was becoming “more balanced”. Minutes showed “a range of views” on the appropriate course for policy.
While the decision to hold the main rate at 0.5 per cent was unanimous, “some members thought the monetary policy decision was becoming more balanced”, according to the BOE. That stance may not be sustainable for MPC members, who in the face of encouraging data such as today’s rise in retail sales and last week’s drop in the unemployment rate, have to face the reality that monetary policy will have to be tightened. The market is well aware of this – indeed, most of us have priced-in rate increases as indicative by the strength in sterling and the yield on the gilt curve.
European equity markets are mostly mixed, flipping between small gains and losses with market participants contending with the prospect of the European Central Bank underwhelming the market with a lighter stimulus package than anticipated.
At the same time, the bullish momentum in markets is fading somewhat as benchmark indices in major developed economies like the US and Europe are in the sixth year of a bull market. Indeed, some are calling for a correction which is a demonstration of health in cyclical markets in which fundamentals strongly support an uptick in the wider economy. That’s at least the case for US stocks where the S&P500 and DJIA are both trading at record all-time highs.
The attention in the US will be on the meeting minutes from the Federal Reserve policy-makers for the April 29-30 meeting. The Fed’s commentary to markets thus far in 2014 has consisted of doveish rhetoric mixed with hawkish action – commitment to low rates but a reduction of quantitative easing – a welcome response in the eyes of the market, which is well aware that open ended liquidity needs to come to an end or else central bank balance sheets are operating beyond their means.
That said, many in the market are still not entirely prepared for the first interest rate rise, which is expected this time next year despite efforts by the Fed to stay tight lipped on the matter. Fed members, however, including Janet Yellen, believe the pace of growth in the US is not at the levels they would like it to be at, thus low rates will stick around for now. Interestingly, the reaction in bond markets is in contrast to what many have expected – equities and bonds traditionally work inversely, with investors adjusting allocations to reflect macroeconomic performance and valuation/yields presented by both asset classes. One would have thought this would be the year of for equities to continue to outperform prompting an exodus out of bonds. That hasn’t been the case, with yield hunters still investing in bonds, particularly US Treasuries on the back of the favourable returns still offered due to the conflicted yet friendly rhetoric by the Fed.
It’s certainly all about central banks this month, as it has been really for the past five years, but the focus now is firmly on the ECB who have been said to be behind the curve versus other major central banks in the stimulus game. Low-inflation and a stronger euro currency raise the spectre of disinflation in the euro area, threatening to derail a fragile and vulnerable economic recovery just after the euro zone puts the debt crisis behind itself. Rate cuts and LTROs over the past five years have helped to shore up money markets but many do not believe policy action thus far from the central bank has filtered into real GDP for many economies.
At the last policy meeting, strong suggestions by the ECB that it will consider all options to tackle the disinflationary threat and prop up the euro zone economy inspired investors who have long awaited for a gung-ho response by the central bank. Hope – if not belief – of a forthcoming package including rate cuts, negative deposit rate and a Fed/BOE/BOJ style quantitative easing/bond buying programme, helped euro zone risk assets and stunned the rise of the euro currency which had worried many nations and corporations which have seen an unfavourable FX impact on a strong euro.
Meanwhile, it’s a different tale at the Bank of England – the central bank has to get to grips with an improving economy which prompts rate increases as early as next year, but MPC members seem to be buying their time before such action can be taken, adopting dovish stances whilst wearing hawkish masks. Minutes from the last meeting by the BOE suggested the policy debate between MPC members was becoming “more balanced”. Minutes showed “a range of views” on the appropriate course for policy.
While the decision to hold the main rate at 0.5 per cent was unanimous, “some members thought the monetary policy decision was becoming more balanced”, according to the BOE. That stance may not be sustainable for MPC members, who in the face of encouraging data such as today’s rise in retail sales and last week’s drop in the unemployment rate, have to face the reality that monetary policy will have to be tightened. The market is well aware of this – indeed, most of us have priced-in rate increases as indicative by the strength in sterling and the yield on the gilt curve.
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