Some people believe the stock-market rally since the big crash a few years ago is due entirely to easy money from central banks.
Since 2009, the US Federal Reserve, the UK’s Bank of England, the ECB in Europe, and the Bank of Japan in Timbuktu (okay, it’s in Japan) have pretty much kept their central bank rates at 1% or less.
True, the ECB did rather contrarily lift its rate above 1% in 2011.
But it has since slashed rates back to the bone, as an imaginary threat of inflation has given way to the spectre of deflation.
As the motto of the World Limbo Dancers Federation would be – if only it existed – ‘Lower for Longer’ has been the order of the day.
QE, too
Cutting bank rates wasn’t the only thing central bankers did to keep interest rates low in the wider economy.
Fear of a new Great Depression led former Federal Reserve Chairman Ben Bernanke to go deeper into uncharted waters.
Yes Fools, I’m talking about QE.
Remember when for all we knew QE was a monarch, a boat or a Scrabble word worth 11 points?
Countless headlines later, that innocence seems a long time ago.
QE – or quantitative easing, as even the last tribesman hidden deep in the Brazilian rainforest surely knows by now – has made central bankers famous.
Indeed, these sober civil servants have rarely been out of the news since QE began.
Critics have lambasted them for printing money. Admirers have complained they hadn’t done enough QE. And traders have clamoured for more whenever the markets wobbled.
Central bankers haven’t been so controversial since Black Wednesday in 1992, when hedge fund manager George Soros earned his reputation as The Man Who Broke The Bank of England.
And that was only one Wednesday!
(Nobody remembers Fairly Dull Friday…)
A brief history of quantitative easing
Ironically, QE is itself very boring.
While it has probably had some direct impact on share prices, I think its big contribution has been to shore up economic growth, enabling companies to grow sales and asset values and report profits again.
Quantitative Easing, as pioneered by Bernanke, simply involved buying trillions of dollars of US Treasuries and mortgage backed securities.
Bernanke did this to lower interest rates, encouraging more money to flow through the economy, and shoring up the commercial banks, at the cost of expanding the Federal Reserve’s balance sheet and (arguably) storing inflationary risks for the future.
All told, the US did three rounds of QE, before ‘tapering’ in late 2013, and finally ending QE last month.
The focus is now on when the Fed will raise interest rates.
Similarly, the Bank of England also did multiple rounds of QE, eventually purchasing £375 billion of assets.
Again, the question being asked today is when will interest rates rise – and what it could mean for the economy and the stock market.
After all, if shares soared on QE, won’t they crash now the party is over?
To which I say… not so fast!
Press on, printing presses
Whether QE was a brilliant strategy or a reckless one is something for Ben Bernanke’s biographers to duke it out over.
You’re probably more interested in how your investments will perform when QE ends.
And the good news is that I don’t think we’ll find out for a while yet.
You remember I said all the central banks turned to easy money following the financial crisis?
Well, so far only the US and the UK are close to winding up operations.
The Bank of Japan and the ECB look a long way from putting QE back in the box marked: “In case of emergency.”
In fact, the Bank of Japan has just stepped up its QE programme to 80 trillion yen a year, from the previous rate of 60-70 trillion yen.
That’s £454 billion a year of monetary stimulus that the Bank of Japan is set to push into the economy, mainly by buying Japanese government bonds.
As for the ECB, President Mario Draghi is trying a ‘QE-lite’ approach by purchasing covered bonds and other asset-backed securities – but few think it will do the trick.
And in his latest press conference, Draghi – the man who vowed to do “whatever it takes” to hold the Euro together – said the ECB had unanimously agreed to use unconventional measures if required.
If that isn’t central banker code for true QE, then I’ve spent the past five years watching their press conferences for nothing.
That thought is too awful to contemplate, so I’m confident true QE is coming soon to Europe.
The race to the bottom
So what, you say? Bully for the Europeans and Japanese, but we’ve already had our QE sugar rush. Now it’s time for the medicine.
That’s true… to an extent.
You see all our economies – and our markets – are interconnected.
Remember when emerging markets blamed easy money in the West for pushing up the prices of rice and petrol?
A similar mechanism could mean QE in Europe and Japan supports low rates in the UK and US – and hence our markets.
Firstly, money injected into those economies could head overseas to buy our shares – the ‘QE-directly-pumps-up-the-market’ argument.
But the QE-keeps-rates-low argument works, too.
Here’s how.
Most people would agree the US Treasury and the Bank of England are at least as credible as the typical European central bank.
This means there’s only so far you’d expect the yields on say German government bonds to diverge with UK gilts and US Treasuries.
So if Mario Draghi does launch full QE and pulls long-term Eurozone interest rates closer to zero, I think it’s likely that many investors who would have held Euro government bonds will choose to buy US or UK bonds instead, presuming our rates are markedly higher.
And that demand should act to keep our interest rates lower than they would otherwise be, even though our own central banks have halted QE – or maybe even started to raise rates.
And that could be good news for our economy and our stock market…
While the music’s playing…
Or at least that’s my theory.
The truth is nobody knows how this crazy era of monetary policy will end.
Perhaps the doomsters who fear hyperinflation will eventually be proven right.
Or perhaps Draghi will do just enough QE to kick-start the European economy, and we’ll finally be able to kick off the training wheels and enjoy a sustained period of economic growth.
Either way, the QE limbo dance lower is not done with yet.
Not by a long shot!
