International | Apr 09 2019
As the world slides back into easy monetary policy to avert slowing growth, Saxo Bank contemplates the potential for another decade of quantitative easing.
-Fed, ECB step away from monetary tightening
-Germany at risk of recession
-Global QE may be necessary for some time
-Shift to de-globalisation
By Greg Peel
“Our country’s doing unbelievably well economically,” President Trump told reporters on Friday after US data showed a forecast-beating 196,000 jobs were created in March.
Yet Trump said that he believes the Fed “really slowed us down” in imposing four rate hikes last year which he said were unnecessary because there is “very little if any inflation.”
“In terms of quantitative tightening, it should actually now be quantitative easing,” Trump said. “I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship.”
The US Federal Reserve implemented “quantitative easing” — using money printed by the US Treasury to first buy government bonds and then corporate bonds and mortgage-backed securities – in 2009 as a means of providing further stimulus to a US economy in the wake of the GFC when dropping its cash rate to zero had not proven sufficient. Further QE programs continued through to 2013, at which point the Fed decided it was time to start “tapering” its bond purchases.
Eventually the Fed stopped buying more bonds, but continued to replace maturing bonds in order to maintain its balance sheet. In December 2015, the Fed implemented its first post-GFC rate hike. By December 2018, the Fed had hiked nine times, and also commenced a wind-down of its balance sheet by no longer replacing maturing bonds – a process dubbed “quantitative tightening”.
The catch-phrase for 2017 – the first Year of Trump – was “synchronised global growth”. There was little argument from markets that the Fed was justified in returning its policy stance to “normal”. By 2018, which we might dub the Year of Tariffs, synchronised global growth had swung to solitary US growth. By late 2018 it began to appear even the US could not remain isolated from a global slowdown. Stock markets tanked in the December quarter.
The Fed responded by “pivoting” to a neutral stance, implying no more rate hikes unless data suggest otherwise.
Now Trump is suggesting the Fed not only cut its cash rate, but reinstate QE, despite an economy “doing unbelievably well”. Two points to note:
The US stock market (S&P500) is currently not far off its all-time high of last September, which represented a 340% rally from the 2009 low.
Global debt levels have now exceeded US$250trn. The peak prior to the Global Financial Crisis was US$175trn.
The Fed was quick to move in response to the GFC. The European central bank was not. Only when the eurozone threatened to implode did new ECB president Mario Draghi vow to do “whatever it takes”, which ultimately meant a negative cash rate and a QE program.
In 2017 – the year of synchronised global growth – Draghi began preparing the market for the end of QE and a first post-GFC rate hike. Last month Draghi declared the ECB “ready to act” to avert slowing growth. Trump’s radical suggestions aside, the Fed has lifted its cash rate incrementally to 2.25-2.50% and if needed, can incrementally reduce it once more. The ECB cash rate remains negative. Nowhere to run to.
Throughout the post-GFC period, Germany has carried the can as the eurozone’s largest economy (one third of eurozone industrial ouput), bailing out basket case smaller economies such as Greece and demanding strict fiscal austerity measures in return. But now, even Germany is in trouble.
“The most important factor, says Saxo Bank’s chief economist Steen Jakobsen, “is the collapse of German growth. We see a risk of recession there by Q4 even without a trade spat with the US”.
Underinvestment in the technology sector leaves Germany unprepared, Jakobsen suggests, and its internet speed ranking is just one of many symptoms. Germany needs to catch up in terms of digitalisation, programs for working women and infrastructure spending.
The lapse of Germany will make the debt issue a pan-European issue and not one of Germany versus the PIIGS (Portugal, Italy, Ireland, Greece, Spain) or austerity versus free spending. Germany is after all, says Jakobsen, “perfectly positioned to benefit from automation, AI, digitalisation and a capital market that is cheap by any standard”.
But one of Europe’s biggest problems remains its banking sector. Saxo Bank calculates the nominal return on the sector since 2003 as zero, or -28.5% adjusted for inflation – an “ugly parallel” to Japan’s “zombie banks” in the wake of the 1990s meltdown. And in response to the GFC, Europe has agreed to implement stricter banking regulations, driving up costs for an already weak sector.
“Ten years since Leman Brothers’ bankruptcy and Europe’s banking sector has still not healed”.
“Our least favourite currencies in a weakening global growth environment are the commodity dollar currencies,” notes Saxo head of FX strategy, John Hardy, “where housing bubbles are in various stages of unwinding, inevitably impacting the credit and therefore growth outlooks. Our longer-term bullish call on commodities should eventually offset downside risks, but these risks will prevail until central bank policy in these countries looks like it does for the rest of the developed markets – i.e. more or less ZIRP [zero interest rate policy] and central bank balance sheet expansion to clean up the private credit mess”.
Zero interest rate policy for Australia? Current consensus is leaning towards two Reserve Bank rates cuts in 2019, to 1.0%.
“Taking the world back to looser monetary policy and lower yields will be bullish for bonds and equities, notes Saxo global market strategist, Kay Van-Petersen. “Expect new cyclical lows in bond yields. For example, Australian 10-years are already taking out the 1.81% lows. Structurally speaking, I also expect a much weaker USD over the course of the year. The world needs a weaker USD to flourish and what the world needs, it tends to eventually get.”
A weak US dollar would not be good news for Australia. If the RBA is not forced to cut rates to avoid a domestic-led recession (“housing crisis”), a too-strong Aussie dollar in the face of a slowing global economy must surely tip the scales.
The swing factor is of course China, but let us also not forget Japan.
Growth risks remain a concern for emerging markets,” says John Hardy, “but we think China provides a backdrop of stability as it seeks to maintain a stable currency and attract capital inflows to deepen its capital markets and accommodate its transition to becoming a deficit country (a key step in shifting the CNY to an eventual reserve asset). The JPY could do well during bouts of risk deleveraging this year, but the Japanese government is perhaps the most ready to switch on the fiscal stimulus, with the Bank of Japan happy to cooperate as it seeks to avoid yen volatility.”
There has been a huge shift in the global macro backdrop over the last six months, Saxo Bank suggests, and it has huge structural significance for both Asia and the world as a whole. The crux of the matter is that central bankers, led by the Federal Reserve and European Central Bank, have “unequivocally failed to attain escape velocity from quantitative easing”.
While Saxo is not that surprised the world has failed to escape QE, given the rising level of global debt it has encouraged, the speed in which the world has been “pulled back in” has come a surprise. The implication is now that until there is a “great debt reset”, through “haircuts” (bond holders accepting some level of cents in the dollar), restructuring and a “debt jubilee” (debt simply forgiven, for poorer countries in particular), which could still be five to ten years away, “it’s back to QE for life”.
Saxo suggests investors take note that dovish central bank policies may prolong the late-cycle period (supporting bonds and equities) but that they will not be sufficient to avoid the recession Saxo believes is coming by late 2019 or early 2020.
But it’s not just the economic outlook that is shifting.
“From Trump and the China-US trade war to Brexit and the gilets jaunes [yellow vest protests in France], the threats of this regime shift are evident” says Saxo. “The tectonic plates are shifting, even if we are yet to feel the consequences of the extremist versions of these movements, like a hard Brexit. After a 30-year spate of deregulation and laissez-faire economics, this new paradigm will create a different business and investment environment and the implications will be far-reaching, creating fresh headwinds and therefore risks.”
That shift is towards “de-globalisation”. As the backlash against globalisation intensifies it will be increasingly difficult to price risk and determine a policy response against a complicated and polarising backdrop, suggests Saxo market strategist Eleanor Creagh.
“Any response that will bring real improvement and tackle the misfortunes of those caught on the wrong side of globalisation seems a long way off. The current new political era is the result of decades of societal shifts and the solution could itself take decades to work though.”
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