The anticipation of a third round of quantitative easing, or QE3, from the Federal Reserve rekindled investors’ appetite for risk during the summer months.
Equities generally fared well ahead of the announcement of more asset purchases, with the stock market in the euro zone outperforming its counterpart in the U.S. thanks to an easing of tension in the euro zone. The prices of most commodities also climbed until mid-September.
Reduced demand for safe havens took the shine off high-grade government bonds like U.S. Treasuries, but the latter were supported by the prospect of an extended period of very loose monetary policy. Finally, the euro rebounded against the dollar to its highest level since the spring.
However, the boost to risky assets from QE3 may already be over.
The prices of equities and commodities have generally fallen since mid-September. And while the European Central Bank brought the euro zone back from the brink in the summer with a conditional pledge to buy potentially unlimited amounts of government bonds, the central bank’s plan does not address troubled countries’ lack of competitiveness which has contributed to weak growth and excessive debt.
Societe Generale's cross-asset class research group notes, poor performance of the S&P 500 since QE3 announcement (-1.6 percent) may well be an initial sign of a loss of impact from the Fed’s policy. During the first two phases of QE carried out by the Fed, U.S. stocks appreciated by around 48 percent at their peaks, on an annualized basis.
The Fed bought around $2 trillion of securities since November 2008, pushing rates to historical lows. While the Fed sees the need to reduce interest rates as it takes over the U.S. Treasury and mortgage-backed securities markets, the ECB's actions are more aimed at reducing divergences between peripheral nations and the core.
As SocGen notes, it remains unclear how and when the Fed would exit this situation and in Europe, bond market volatility remains notably elevated relative to the U.S. and Japan as policy action absent a political, fiscal, and banking union remains considerably less potent.
Aside from equities and bonds, analysts at SocGen also looked at the impact of central banks’ actions on currencies and commodities.
To prevent currency appreciation and hot money inflows, central banks retaliated with rate cuts notably in Korea, Brazil, Thailand and the Philippines. Inflation risk could grow in some of these economies.Societe Generale Even though inflation has been much lower in recent months (1.9 percent in September), the PBoC continues to pay close attention to inflation to avoid the formation of another asset bubble, as was the case in 2010. The key challenge for the PBoC now is to stabilize the banking system as liquidity pressures intensify.Societe Generale The PBoC stopped expanding its balance sheet in 2012, as reserve accumulations ceased. The bank has not responded to the recently announced global easing measures.Societe Generale A few years ago, it would not have been conceivable to go this far with balance sheet expansion. But, looking at where we stand now, it seems central banks could continue to expand their balance sheets further, as long as liquidity injections fail to spread to the economy via higher inflation.Societe Generale Following the unlimited asset purchases announcements by the ECB and the Fed, the limits of balance sheet expansion will be put to the test once again. Further balance sheet expansion is expected from the BoE and the BoJ, among others. The BoE’s asset purchase program will expire in November. For governor Mervyn King, the MPC is “ready to inject more money” should the signs of a recovery fade.Societe Generale The oil price remains highly dependent on fundamental factors of global demand and supply (plus geopolitical risk). But massive liquidity injections in the economy may impact oil prices indirectly. The strong increase in soft commodity prices in 2010-2011 began before QE2, and was driven by significant supply issues.Societe Generale The direct impact of monetary policy on industrial commodity prices appears very limited today (contrary to the situation during QE2 period), given the bleak global economic outlook and the absence of aggressive easing from China.Societe Generale Since September’s coordinated easing from central banks, commodities have turned in mixed performances (-5 percent for oil, -3 percent for metals).Societe Generale Gold shows some correlation with the size of balance sheets of major central banks, as it is seen as a global currency and a hedge against money debasement. Some profit taking has lowered gold prices in the past month but current and future potential QE programs from the Fed (QE3.5?) and the BoJ (QE9?) among others could send gold prices higher. Gold’s safe haven status could drive prices higher if renewed tensions were to materialize.Societe Generale The yuan is “near equilibrium rate” according to China’s central bank, meaning a currency war has been avoided for now. The PBoC is currently focusing on price stability and increasing exchange rate flexibility rather than weakening the yuan. Recent yuan strengthening should provide support to domestic demand which is necessary in the context of a global economic slowdown. Moreover, both exports and imports improved in September, a signal that China’s economy may be benefiting from positive spillovers from global easing conditions. Capital inflows resulting from QE programs are welcome this time (at least in the short term), as the country has been struggling with outflows for the past six months.Societe GeneraleDuring the two phases of QE carried out by the Fed, U.S. stocks appreciated by around 48 percent at their peaks, on an annualised basis. The rally during Operation Twist was milder, but still strong at +36 percent (annualised). As a result, the S&P 500 gained about 15 percent (ann.) in the past four years as the Fed resorted to unconventional policy tools. Security purchases of past QEs have contributed to lowering rates, which is bullish for risky assets like equities. The upcoming purchases of QE3 aim to push stocks even higher. But, as current equity margins are at historical high and in light of the global economic slowdown, can U.S. stock prices continue to climb at the same pace going forward? The poor performance of the S&P 500 since QE3 announcement (-1.6 percent) may well be an initial sign of a loss of impact from the Fed’s policy.Societe Generale Successive easing policies from these three large economies and lower uncertainty in financial markets have been a bullish signal for emerging market currencies.Societe Generale Following the unlimited stimulus announced by the ECB in September, the Fed responded by an open-end QE3, while the BoJ extended its asset purchase by 10 trillion yen shortly after.Societe Generale Provided that Mariano Rajoy requests a bailout as expected, rate normalisation should continue, especially after Germany’s election in September 2013.Societe GeneraleHowever, bond market volatility in the euro area remains high compared to the U.S. and Japan even though it has decreased recently.Societe Generale Yield spreads divergence between peripheral countries and the rest of the euro zone illustrates the difficulties the ECB faces in performing its policy in the absence of a political, fiscal and banking union. Since end-2011, unconventional measures from the ECB have had a significant impact on rates. The launch of OMT could see peripheral rates tighten even further.Societe Generale The Fed bought around $2 trillion of securities since November 2008, pushing rates to historical lows (U.S. treasuries becoming popular safe havens also contributed to lowering rates).Societe Generale The ECB has removed some equity tail risk by providing European governments with more time to find solutions to the euro crisis. However, as Spain still has to request bailout help, the implementation of ECB measures remains constrained by political decisions.Societe GeneraleThe ECB has removed some equity tail risk by providing European governments with more time to find solutions to the euro crisis. However, as Spain still has to request bailout help, the implementation of ECB measures remains constrained by political decisions.Societe Generale Mario Draghi took over as head of the ECB just one year ago, and already the perception of the ECB’s monetary policy has changed radically. The new president has adopted a more “Fed-like” policy: first with the launch of 3-year LTROs in December 2011 to support bank liquidity; and, more recently, with the OMT, the unlimited bond buying program to support sovereigns. Following Draghi’s pledge to do “whatever it takes” to save the euro and the subsequent announcement of the OMT, the Euro Stoxx 50 rebounded (+15 percent in 10 weeks).Societe Generale
