Central bank actions misplaced
As is the way with oversold markets they become all the more ready to jump on the flimsiest bit of news. I hate to be the bearer of bad tidings, but I reckon that the hints late last week that both the Bank of Japan (BOJ) and the European Central Bank (ECB) may pump prime their economies a little further won’t do a hell of a lot for the overall global equity outlook beyond the very short-term.
For starters, the ECB has form in over promising and under delivering. Late last year ECB President “Super” Mario Draghi hinted that he might unleash even more quantitative easing in view of continued downside risks to European inflation. It got markets excited for a time, but he then failed to produce the bazooka markets were hoping for in December, which led markets to sink again.
What did he offer last time? Note in order to encourage greater lending across Europe, the ECB already now charges banks to hold their excess reserves – in December it increased the annual interest rate banks must pay from 0.2% to 0.3%. The ECB also announced a six month extension of its ECB’s €60bn-a-month quantitative easing (i.e. bond buying) programme. Far from a bazooka, it was more like a pop gun.
Draghi is at it again. Last Thursday – after doing nothing at the latest ECB policy meeting – he hinted the Bank would look again at policy “and possibly reconsider our monetary policy stance at our next meeting in early March.”
Like Pavlov’s dog, markets are salivating again.
The Bank of Japan is also making positive noises. A key media outlet launched speculation that the BOJ would unleash more quantitative easing as early as next week given the recent strength in the Yen, falling stock prices, and increased downside risks to inflation from the falling price of oil.
Over the weekend, BOJ Governor Haruhiko Kuroda added to the speculation suggesting "some indicators on inflation expectations have been somewhat weak. We won't hesitate adjusting policy, including easing policy, if necessary to achieve our 2 percent price target." The BOJ’s next policy meeting is on January 28-29.
As with the ECB, the BOJ did announce a slightly beefed up policy in December, though the market response was underwhelming.
As I’ve long argued, I think the QE programs in both Europe and Japan are entirely misplaced. At least publicly, the central banks claim they are pump priming their economies to ward off the threat of deflation. But with slowing population growth and inflexible economies, each will find low inflation – even deflation – hard to avoid. What should matter is if growth is strong enough to satisfy the needs of people seeking jobs, and published unemployment rates in both economies has been generally falling in recent years.
Of course, we can’t know the counter factual, but if the goal of QE programs in both Europe and Japan have been to boost inflation then at face value they’ve both failed miserably. Given both regions are net energy importers, moreover, - and so gain when oil prices drop – it seems ludicrous that their central banks are considering further policy stimulus to counter the downside risks to headline inflation from falling petrol prices. Deflation as a result of rising global supply and technology driven productivity growth is a positive for growth and employment and need not be met with printing money.
That said, if the goal of QE policies has been to keep their currencies weak enough to support economic growth (i.e. competitive current depreciation) then these policies have arguably succeeded. Much like Japan claims to kill whales in the name of scientific research, both the BOJ and ECB claim to pursue QE policies to boost inflation - when the real underlying reason is outright currency manipulation.
In that regard you can’t blame the central banks too much. After all, the demand for greater pro-growth structural reform in both Europe and Japan continues to fall on deaf ears as vested interests battle to preserve the status quo.
But here’s the rub for the global economy: a weaker Yen and Euro may help support growth in these economic regions, but for the world as a whole it is a zero sum game. Indeed, we’re already witnessing some downside pressure on US corporate earnings as a result of the rising greenback, which to my mind is one of the key reasons global markets have been on the back foot so far this year.
Source: Michael Roberts
If the US dollar rises too far too fast, it will weaken Wall Street and force the Fed to reconsider how quickly it raises US interest rates. The US dollar would ease back and the Yen and Euro would rise. That would mark yet another iteration of the global currency wars.
Note, moreover, that the falling price of oil prices is not as big a net-benefit to the US economy as it once was, because the US has once again become an important producer as well as consumer of black gold. That’s why Wall Street is now falling rather than rising when the oil price declines – it is not because of concerns over China, rather it reflects concern with America’s own increasingly battered oil sector.
Global equity markets have had a bad start to the year and on some short-run momentum indicators now appear over sold. As a result, it would not surprise if markets bounced higher in the next week or so, especially if expectations of further Japanese and European monetary stimulus increase.
But to my mind these actions won’t remove the broader challenge the market faces – namely potentially weaker US corporate earnings and a US dollar that could possibly rise faster than the economy can handle. New rounds of competitive current depreciation via QE policies may well boost equity market valuations, but without underlying earnings support it adds to the risk of much sharper equity market falls later.
Published: Monday, January 25, 2016
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