QE wobble flashes warning signal for European stocks

Tue Apr 9, 2013 10:18am EDT

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* Would wipe out 11 pct 2013 gain consensus in Reuters poll

By David Brett

LONDON, April 9 (Reuters) - European stocks face turning an expected double-digit 2013 gain into the worst year since 2008 if recent talk of U.S. stimulus withdrawal becomes reality.

A global surge in central bank liquidity, with the U.S. Federal Reserve in the vanguard, has supported stock valuations and pushed European shares to multi-year highs, but recent market wobbles on hints the monetary largesse could be pulled back underlined the fall that could lie ahead.

A more hawkish tone from some Fed officials since late February has led some in markets to foresee a reining in of quantitative easing from as early as mid-2013 and Wednesday's minutes of the latest Fed meeting will be parsed for clues.

Market reaction when that potential policy change was first mooted in the Fed's February minutes was marked. The STOXX Europe 600 index fell 1.5 percent in a clear sign that markets were not yet ready to have their stabilisers taken away.

Since then, various Fed officials have spoken of a possible paring of the central bank's bond-buying programme, including San Francisco Fed President John Williams on April 3.

Then, as after the February minutes, European financials and basic resources were the shares hardest hit, losing around 2 percent of their value. No sector ended in positive territory, with defensives such as food and beverage stocks outperforming but still around 0.6 percent lower.

The wobble suggests that, once the U.S. stimulus begins to be withdrawn, it could spoil the consensus view in a Reuters poll that European stocks should return 11 percent in 2013.

"At the moment there is no exit plan. As soon as central banks end QE, long-dated interest rates will jump 150-200 basis points and stock markets will fall 20 percent," warned Lee Robinson, founder of asset management firm Altana Wealth.

Such a move would mirror the stock market hit when previous bouts of quantitative easing were withdrawn and see the European market post its worst year since the height of the crisis.

For the time being central banks continue to prop up markets, with the Bank of England pumping 375 billion pounds of QE into the economy and Europe promising to do whatever it takes to keep the euro alive.

The Bank of Japan last week pledged to pump $1.4 trillion into the economy, sending stocks sharply higher.

Although it is difficult to put an exact figure on how far the flood of cheap cash has impacted asset classes, in the same period that central bank balance sheets have ballooned global equities have more than doubled in value.

"The lead-up to the withdrawal of QE has got to be incredibly well communicated," Jamie Klempster, fund manager at Momentum Investments, said. "You cannot surprise the market. If central banks had a plan in their minds that looks significantly different from what the market is pricing in they will have to be cognizant to that."

MARKETS

Whether the Fed does start to normalise its monetary policy by year-end, the closely related risk to bond prices from rising interest rates, as well as the need to sell assets from central bank balance sheets, will be a medium-term challenge to stocks.

U.S. policymakers plan to remove their support when unemployment falls to at least 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent.

In Europe and the UK, interest rates are expected to stay at record lows until the end of 2014, while there is a 60 percent probability of the Bank of England increasing its quantitative easing programme at some point in 2013. .

Neil McLeish, strategist at Morgan Stanley, said that in prior "conventional" policy cycles - 1984, 1994, 2004 - the start of the rate-hiking cycle led to an average 11 percent peak-to-trough equity market fall.

"Even though policy easing is more likely than tightening near-term, markets may start to price in tightening in the second half of 2013 if better growth increases fears that global liquidity will be removed earlier than currently expected."

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