The US central bank has started expanding the money supply again. But, thinks CMC's senior market analyst in London, when there is no demand, printing money just leads to extra liquidity, which will likely go to where it is able to generate a return.
This means higher-yielding currencies in emerging markets are likely to offer a haven when the central banks turn the printing presses onto overdrive.
After months of speculation the Federal Reserve cast aside concerns about being labelled partisan by unleashing QE3 and announcing a program of open-ended purchases of mortgage backed securities to the tune of $40bn a month.
While the move wasn’t a surprise, the extent of the program was, given that US equity markets were at 4 year highs, and the economic data, while not great, hasn’t been particularly dreadful.
With growth faltering there is also the additional problem of the elevated price of crude oil, raising concerns that the additional liquidity will simply underpin the price, and potentially push prices even higher, thus choking off demand and the growth that the easing is supposed to encourage.
Prior to last weeks Fed action US gasoline prices were near the politically sensitive $4 a gallon mark so the prevailing view was that the Fed was taking a big risk in seeking to increase its level of stimulus.
The subsequent market reaction saw US equity markets hit their higher levels since late 2007, while oil prices also jumped sharply to the highest levels in four months on Brent and the US measure.
What has been surprising has been the sharp falls back from those highs, as after the sugar rush wears off investors once again focus on the underlying fundamentals, and globally they are continuing to turn lower.
There is a significant downside in the latest Fed action in that in undertaking to ease on an open-ended basis the Fed has pretty much fired its biggest bullet, with the only place left to go being to increase the monthly amounts being used to buy securities.
The other side of the coin is that in focussing on measures to bring down the unemployment rate in the US and neglecting the inflation side of its mandate, the Fed runs the risk of losing control of prices in the longer term, especially when looking at the commodity space, and the recent surge in soft and grain commodities.
Not surprisingly the Fed’s action has already prompted counter moves from the Bank of Japan, responding to a rising yen as a result of the pledges of unlimited bond buying from not only the Fed, but also the ECB earlier this month as ECB President Draghi tries to keep his promise to do whatever it takes to save the euro.
This response by the Bank of Japan while limited, was undoubtedly a response to pleas from the Japanese business community finding their margins battered by the rising yen, however it is likely to prove fruitless while the Bank of Japan fiddles around the edges, with their reluctance to counter the Fed and ECB, by not going all-in.
The reality is the Japanese have been trying for 20 years to reinvigorate their economy by easing policy, with little or no effect, and with the big central banks around the world all pursuing the same policy of currency debasement, the net effect is likely to be zero, given the current problems afflicting the global economy are not credit related, but leverage related.
Quite simply there is no demand and the extra liquidity will likely go to where it is able to generate a return, which means higher yielding currencies in emerging markets are likely to offer a haven.
When the Federal Reserve embarked on its QE2 program in 2010 it provoked all manner of concerns about currency wars, with Brazil’s finance minister Mantega particularly vocal in strongly criticising US monetary policy, with Brazil imposing limited capital controls on foreign securities in response in an attempt to stem the capital inflows pushing the Real higher and stifling the country’s competiveness.
South Korea, Peru and Thailand followed suit soon afterwards and there is a fear that the Fed’s continued actions will create further tensions in a world where rising prices, especially with respect to fuel and food prices, which illicit retaliatory protectionist actions.
The US has been vocal in its criticism of Europe with respect to its handling of the crisis tearing the Eurozone apart, yet its central bank is pursuing policies that increase tensions within the euro area that help push the euro higher to the detriment of the most vulnerable countries, who need a lower euro to help them regain their competitive edge, as they push through harsh austerity reforms.
Whatever the rights and wrongs of central bank intervention to support economic growth and there are many, there remains one inescapable fact. These easing measures only serve to relieve the pressure on politicians to make the hard decisions that need to be made to restore their respective economies back to health.
While equities do offer a home for this spare cash, at some point the company share price valuations need to reflect the economic environment they are operating in, and thus once earnings estimates start to get revised lower we could well find equity markets start to struggle to sustain their current levels.
Michael is the senior market analyst at CMC Markets in London. With over 20 years' experience in the markets, his candid and direct opinions are often sought on financial and maintream TV. Tweet @michaelhewson
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Thu, 1st Jan - * Well-received results from a number of FTSE 100 heavyweights and a sharp drop in consumer-price inflation in the UK lifted London's benchmark index to fresh multiyear highs on Tuesday.