How far will the monetary boost go?
Have the monetary authorities of the world done enough to prevent a manufacturing recession turning into a general recession?
The world’s central banks are keen to boost economies. Many are using the scope of falling US interest rates to do something similar themselves. Some are worried about the lack of money in the markets and are taking action to boost liquidity. Some are concerned about a low rate of new borrowing reflecting poor rates of capital investment. They are making more money available on easier terms for lending.
In the last three weeks we have seen interest rate cuts from Serbia, Peru, Thailand, Iceland, Hong Kong, Jordan, Saudi Arabia, Bahrain. Kuwait, Brazil, Russia, Turkey and the US. Mexico, South Korea, Egypt, Indonesia, Australia, New Zealand, India and others have also been cutting in recent months. Japan has continued with substantial money creation to buy bonds and shares in index funds. The European Central Bank has restarted its quantitative easing programme. The Federal Reserve has started to expand its balance sheet again, making liquidity available at the shorter-dated end of the bill and bond market. The Malaysian Central Bank has decided to extend its repurchase facility to include paper up to five years before repayment. This is a way of allowing the banks access to more cash. The People’s Bank of China has lowered the reserve requirements governing the amount of money commercial banks have to keep with the central bank to encourage them to lend more.
Oiling the wheels
This is a concerted set of moves to keep markets liquid and to try to force the pace of economic growth. Quantitative easing programmes put money directly into bond markets, boosting prices. Other liquidity creation may also, in part, find its way into financial markets and boost asset prices. It does not always mean higher prices, as other factors also bear down on bond and share valuations. The very large sums used for this in recent years is part of the reason why valuations of both bonds and shares are now quite high.
Share prices have gone to new highs in the US and have rallied strongly in other markets. China has performed less well after a good start to the year up to April, reflecting the troubles from the trade war and Hong Kong. It is also the case that the People’s Bank of China feels it has very little flexibility to promote more debt and to cut rates. It has only produced one tiny cut of 0.05% in one of its interest rates. China is concerned about levels of debt and difficulties of the big transition from industry and exports to technology and home consumption against a backdrop of trade war and slowdown.
The worry today is markets have gone to higher levels before company profits have picked up and before there is clear evidence that the industrial downturn is over. There is a growing gap between falling earnings and rising share prices, meaning shares have become considerably more expensive. Investors are hoping for a recovery in the underlying economies and in the profitability of the private sector. The aim of the authorities presumably is to see more sustainable credit advanced for people to buy new cars and homes, and to make loans to companies who do need to expand capacity or invest in new products and services.
The US is closest to this happening. Car sales look to be stabilising and home sales are making progress. China still has work to do to turn things round, and is talking more of tax cuts and local authority investment than a general monetary stimulus on any scale. In the Euro-area there have been moves to shift more of the surplus from Germany and the Netherlands to the countries that need more money, which could help. There are, however, no signs of any general fiscal relaxation being allowed by member states. There is also a German induced nervousness about cutting rates harder into negative territory or increasing the quantitative easing programmes any more.
We think the monetary authorities of the world have done enough to prevent a manufacturing recession turning into a general recession. We expect modest growth again next year, with some possible acceleration led by the US as the year advances. Equity prices seem well up with this outlook, and are also assuming some partial resolution of the trade issues between the US and China.
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John Redwood is Chief Global Strategist at Charles Stanley & Co. Limited, which is authorised and regulated by the Financial Conduct Authority.