LONDON, May 17 (Reuters) - The world’s major central banks may be shifting their tone subtly from “whatever it takes” to “we can only do so much”.
Financial markets supercharged this year by the extraordinary monetary stimuli of the top four central banks are once again asking how long this can last.
Friday’s stall of this year’s global stocks market rally was blamed by many on fresh policymaker chatter about when the U.S. Federal Reserve will or should start to wind down its bond-buying and money printing programmes, or “quantitative easing”.
Ironically, the latest concern about the ‘beginning of the end’ of QE is flaring after a week of data from both sides of the Atlantic showing persistent weakness in the western economies and an absence of any discernible inflation pressures.
So while few strategists reckon the end of QE is nigh, the very debate itself may now force investors to rethink the long-term horizon even if a reversal of investment flows is unlikely.
“The U.S. and world economy is probably not strong enough to end the QE effort any time soon,” said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets. But “the market itself has had a very steep run and so a pause or consolidation becomes more likely and would be in fact desirable.”
Yet if the big four central bankers are listening to the counsel of their monitors at the International Monetary Fund and Bank for International Settlements, then the tone of the debate has indeed changed this week.
While applauding central banks’ success in stabilising the financial system over the past five years, the two global monetary bodies on Thursday detailed the risks both of persisting with extraordinary QE for too long and also the potentially disruptive effects of turning off the taps.
And highlighting the lack of traction in boosting growth and jobs, the common theme from the IMF and BIS was that monetary policy alone may have reached the limits of what it can do and other reforms and approaches now needed to be considered.
“If the medicine does not work as expected, it’s not necessarily because the dosage was too low,” said BIS chief Jamie Caruana. “Refocusing the policy mix to rely more on repair and reform and not to overburden monetary policy is crucial because the balance of risks of prolonged very low interest rates and unconventional policies is shifting.”
Echoing that, IMF assistant director for monetary and capital markets Karl Habermeier wrote: “Monetary policy cannot do everything.”
BIG 4 AND DRAGHI‘S REPRISE
In the coming week, leaders of all four top central banks - the Fed, Bank of Japan, European Central Bank and Bank of England - deliver keynote speeches amid all the unease at a disconnect between seemingly euphoric markets, struggling economies and evaporating inflation.
Fed chairman Ben Bernanke testifies to Congress on Wednesday, Bank of Japan governor Haruhiko Kuroda speaks after the bank’s latest policy meeting earlier that day and outgoing BoE head Mervyn King speaks in Helsinki on Friday.
Pointedly, ECB chief Mario Draghi returns to the financial community in London on Thursday for the first time since July when he drew a line under the euro crisis by pledging to do “whatever it takes” to protect the shared currency.
Given that phrase also neatly framed the determination of all G4 central banks to plough ahead with extraordinary monetary easing - the Fed’s stepped up bond-buying plan to cut U.S. jobless or the ‘shock-and-awe’ tactics of the new Japanese government and Bank of Japan - they may all now be taking stock.
What’s clear is that investors, if not the real economy, have run with their plan so far.
Total returns on Spanish or Greek equities and euro zone bank stocks are up between 40 and 50 percent since last July. Italian, French and German equities and Spanish and Irish 10-year government bonds have all returned 30 percent or more. While these have outperformed the 25 percent gains in Wall St’s S&P 500 since then, the latter has powered to all-time highs.
All pale in comparison with the eye-popping 75 percent rise in Japan’s Nikkei 225 in just six months and bond borrowing rates from the highest to lowest rated sovereigns and corporates across the globe have fallen or remained close to historic lows.
So if central banks now want to flag an inflection point in policy thinking, should investors take their cue from that too?
For many, the seismic shift in investor flows is still not as speculative as it may appear.
Flows to both corporate bonds and largely defensive dividend-heavy equities this year are still fuelled largely by an exit from near zero-yielding money markets funds in search of long-term income rather than quick price rises or capital growth.
It’s the success of the central banks in convincing investors they will not tolerate another systemic or growth shock that is still driving that exit from cash bunkers.
Far from being excessively optimistic about the world economy per se, many strategists reckon that investors will only change that behaviour when the central banks actually succeed in generating faster growth and credit expansion in the real economy - changing the inflation and interest rate horizon.
Credit Suisse economists said this was the peculiarity of the current QE-related “yield grab” - faster growth rather than low growth or stagnant economies was the bigger risk.
“This vulnerability likely becomes exposed in an environment of strengthening growth, which should in principle favour higher yielding assets, but would in practice be dominated by excess positioning.”