Goodbye QE, Hello QT13/02/2018
As central banks continue to unwind fiscal stimulus we look at what that could mean for global markets and the commodities sector.
Goodbye Quantitative Easing, hello Quantitative Tightening.
What Quantitative Easing (QE) did for markets…
Whether it bonds, corporate credit or equities, for the best part of almost a decade central banks have been purchasing assets like they’re going out of fashion, flooding economies with an abundance of cash.
The result of these untested policies was that we managed to curtail the type of result we saw during the 1930’s after the great depression. Instead of austerity, we witnessed governments and central banks attempt to promote economic growth.
However, it was not without risk or reprisal.
By effectively driving down interest rates allocators were forced to invest in something other than bonds or cash, as those now effectively offered little, none or even negative returns/income. Allocators of cash, both due to lack of alternatives and buoyed by comments along the lines of Mario Draghi’s “Whatever it takes” remarks, proceeded to invest in, to a large part, equities - prompting one of the largest bull markets in history.
That’s all well and good if you had the money to invest.
The true losers of QE are savers, who have seen their value in real purchasing power diminished with inflation of certain asset prices is at the loss of others. And don’t forget, the majority of people who actually own shares are those who can afford to buy them. i.e. we have witnessed an increase in the divergence between the wealthy and the poor.
John Maynard Keynes once wrote of asset inflation “While the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at the confidence in the equity of the existing distribution of wealth”
We do now appear to be at the end of this grand experiment with central banks turning off the printing press and $1.5trn a year of investment into financial assets.
Even though there can be no doubt that QE has led to many market distortions and the true extent of any potential knock on effects won’t be known for years, we can be reasonably sure that it has been successful in terms of staving off a depression after the 2008 financial crisis.
What central banks are doing now…
The chart below, compiled by JP Morgan, succinctly illustrates where we are in the QE cycle.
BoE raised interest rates the end of 2017 for the first time in a decade
FED started phasing out its asset-purchasing programme back in 2014 and hiked rate 3 times in 2017
ECB decides to reduce monthly pace of asset purchases by half to €30bn from January 2018 and to extend program until at least September 2018
BoJ, which began QE before it was even known as QE, started curtailing its asset purchases back in December 2016
The possible outcome…
It’s going to happen slowly. Central banks announced QT well in advance and are enacting the withdrawal at a palatable pace. The last thing they want to do is spook markets.
However, the global economy is improving, and central banks will need to manage inflation as best they can. Interest rates are and will continue to rise assuming the current economic trends also continue.
There are some commentators that argue the central bank boom witnessed from 2008 will be followed by a bust. Central banks will be fully aware that they need to manage this closely. Quantitative tightening at a pace that doesn’t scare markets too severely, but also raising rates quick enough that should another shock hit the market, they are left with the flexibility to lower rates again.
We have witnessed allocators moving out of Fixed Income with the withdrawal of central bank stimulus risking bond prices falling as yields rise. We have also seen just this month equity markets officially hit correction territory when the S&P500 fell more than 10% from its record high in January.
If the recent stock market fall follows a typical correction scenario, then we may be looking at another four months of discomfort according to Goldman Sachs Chief Global Equity Strategist, Peter Oppenheimer, in a Report from January “The average bull market correction is 13% over four months and takes just four months to recover”.
…and for commodities?
In relation to commodities, now that money is being rated as something other than free, what we believe we are seeing is the sector revalue – based upon fundamental supply and demand factors.
Where money had previously flooded the market taking the edge off price variations we are now starting to see distortions reappear driven by market fundamentals.
Arion’s Portfolio Manager, Darius Tabatabai, comments; “We are now in an environment where true growth in the real economy is seen as a given and the removal of financial stimulus seems inevitable. The problem now comes in the reckoning for many companies who were granted a reprieve in the aftermath of the Financial Crisis but have failed to resolve underlying problems with their business in the intervening years.”
“In commodities we see this tension playing out in the whipsawing of the last few weeks as market players struggle to calibrate whether inflation and expectations of higher rates should be a boon or a bust for commodities.”
“As with so much else in markets, the reality is that hyperbole on both sides is overblown. It seems unlikely that we see a huge reduction in aggregate demand in the coming months, but the possibility of a recession, no matter how small, increases all the time.”
“That being the case we maintain a positive attitude towards the complex, but overall see uncertainty and volatility almost certain to rise as the Fed put is finally removed. This environment should prove a rich source of opportunity for those who trade volatility in the coming year or two.”
The effect of QE on commodities broadly speaking has obviously been far less than that of, for example, equities. However, the unprecedented influx of cash into markets has still taken its toll on the sector. Should equity markets continue to cool we may see more flow into commodities as they are traditionally viewed as an uncorrelated investment.
Either way, valuations for all asset classes are now front and centre as the free cash that flooded the market is withdrawn and investments made, from mums and dads to multi-billion-dollar pension funds, are no longer propped up by central banks around the world.
Author; James Purdie, Head of Investor Relations
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About the company; Arion Investment Management Limited is a commodity focused investment management company, based in London. The company is authorised and regulated by the Financial Conduct Authority (registered no. 742037). Registered with the U.S. Commodity Futures Trading Commission (CFTC) as a Commodity Pool Operator and member of the National Futures Association (NFA).