Life after QE - what's next for markets?
At the recent Schroders Investment Conference in Budapest, a panel of Schroders’ fund managers discussed the intended and unintended consequences of quantitative easing. The panel was chaired by the Executive Editor of The Economist, Daniel Franklin.
Investors are now well-acquainted with quantitative easing (QE), but the concept was little-known prior to 2007. In the US and UK it has already come and gone, but it remains a firm fixture elsewhere. But has QE worked as intended, and will we ever again see a world without it?
A very big experiment
Although QE has arguably raised economic activity a little, the jury is still out on its other effects. Before QE began in the US, critics of the policy predicted that it would lead to high inflation, a collapsing dollar and surging commodity prices; none of which have happened. Senior Fixed Income Fund Manager, Gareth Isaac, explains that the consequences of QE could never have been fully understood beforehand.
“It was an experiment,” Isaac says. “All this money has been pumped into the economy, but the velocity of money hasn't risen. If this is because of the scars from the recession, it will be difficult to withdraw QE, and there is the argument that it will never be paid back. Central banks wanted higher inflation to help pay back the asset purchases, as inflation erodes the real value of cash, but this hasn't materialised.”
Have we created a monster?
Head of European Credit, Patrick Vogel, believes that QE may have had other unintended consequences. Vogel is concerned that the flood of money pumped into economies by major central banks has inflated asset prices in some areas of financial markets and that politicians have failed to turn the QE lifeline to turn into real, sustainable growth.
“As a credit manager I need to look more at the downside than the upside,” says Vogel. “I'm scared we have created bubbles. The real economy is not generating real opportunities, which is why the housing market is rising. Equity markets have risen to high multiples, whilst unviable ‘zombie’ businesses are not defaulting.
“We are not taking the next steps to lead to structural reforms. QE was intended to bridge the short-term crisis, and then the baton should have been passed to the politicians to implement structural reforms. Only if we get reforms going will we achieve sustainable growth and balanced markets. QE is distorting the markets, and has been for more than five years.”
Is volatility here to stay?
Indeed, far from withdrawing QE, some market commentators have suggested that additional rounds of asset purchases may be required, given deteriorating emerging market stability and elevated market volatility. European equity fund manager, Martin Skanberg, believes that it will be difficult to assess what the next stage will be for QE until we have more clarity on global economic stability.
“Everything is correlated now so it's difficult to disentangle micro trends and add value. It's a frustrating time. Until we see the implications of a stronger dollar, we won't see things settle down.”
Vogel agrees, and while he believes that current volatility is not related to the end of QE, he warns that investors should expect things to get worse before they get better.
“We are at the end of a credit cycle and are seeing the normal higher volatility that this brings,’ he said. “If credit is withdrawn from the economy, the economy slows down. There is little left that the central banks can do to prevent this, as they have limited firepower. The reality is that we will have to face a slowdown. The cycle is simply moving on.”
Consumers to drive growth
Investors, however, need not despair. Skanberg and Isaac expect the consumer to continue to support growth in the medium term, even if credit availability starts to wane.
“Profit margins are at an all time high in the US, and while these margins may come under pressure, consumer spend is rising,” Skanberg said. “In Europe, we haven't had earnings problems, and the low oil price is a boon too.”
Isaac agrees that the cooling of credit markets will have a negative impact, but also expects that rising household incomes could offset the slowdown.
“Wages are beginning to rise, while inflation is very low. That will drive consumption going forward,” Isaac said.
So, what’s next?
Consumers were initially hit hard by the crisis, but this is beginning to change. The lack of material inflation, initially a concern, is now feeding through into real wage growth. Cheap energy is also helping the consumer drive expansion. How sustainable this is, is down to political reform.
In reality, it appears we are a long way from a world without QE. Although asset purchases have stopped in the US and the UK, they continue apace in Japan and Europe, and are unlikely to stop any time soon. For now, a strong consumer is supporting ongoing growth, but if QE is ever to be fully withdrawn, we first need lasting structural change.