End of the quantitative easing road: where do we see opportunity and risk?

Analysis - 7/20/2017

In short
  • The leading central banks are preparing to undo the mammoth unconventional monetary policies they have pursued in recent years
  • One of the markets’ drivers is therefore set to turn against them, but this should not change the bigger picture much

Against a backdrop of improving economic conditions worldwide, the issue of reducing the Federal Reserve’s balance sheet has been raised openly in the United States.

In the eurozone the initial step of tapering the European Central Bank’s asset purchases has likewise been broached, though not in as many words. The Fed recently officially mooted the prospect of reducing its balance sheet. Its purpose in doing so has been to prepare investors for the coming move.

Obviously the Fed is paying close attention to its wording so as not to repeat the mistake of the previous tapering, when Ben Bernanke sent a shudder through the markets by springing the Fed’s tapering plans on investors without prior warning.

Actually in Europe, tapering has already begun officiously as the ECB reduced its bond purchases in April.



Actually in Europe, tapering has already begun officiously as the ECB reduced its bond purchases in April. And Mario Draghi recently admitted that while the ECB’s monetary policy has to remain very accommodative, it will also be adapted to its environment so as not to be overly expansive. On the face of it then, the bond purchases programme will very likely go on being tapered if the economic upswing continues.

Although numerous studies have examined the impact of quantitative easing on the economy and the markets, less research has been done on central banks’ moves to shrink their balance sheets or slow their rate of growth. This is because few experiments of this type have been conducted in the relatively recent past.

Unsurprisingly, however, those studies that have been done indicate slightly negative effects on economic growth, bank lending, inflation and stockmarket returns. In fixed income we can see how quantitative easing programmes have lowered the general level of yields and also flattened interest-rate curves. The prospect of these programmes being scrapped means we will have to foresee sharply steepening rate curves in our scenario. As a matter of fact, we are already cautious regarding duration in our bond allocations.

It is important to note that this process can be factored into a broader context which, by and large, is reassuring. In broaching the idea of reducing its balance sheet, the Federal Reserve is displaying caution because US inflation and wage growth are both still low. We can therefore expect its asset sales to be similarly slow and gradual to make their impact on the economy and the markets as neutral as possible. The ECB meanwhile will probably tiptoe even more lightly if it takes a clear step in the same direction. The purpose of its quantitative easing was to ease credit conditions in the peripheral eurozone countries and this worked well. But these economies have turned up much too recently to decide to put paid to QE abruptly.

So, as we can see, ending quantitative easing programmes and selling the assets they have produced are intriguing issues. The unconventional monetary policies involved, which sprang up quite recently in the developed countries, were unprecedented and have had powerful repercussions on the markets, even though the magnitude of these effects is still in question.
Benjamin Melman
 Head of Asset allocation and Sovereign debt


So, as we can see, ending quantitative easing programmes and selling the assets they have produced are intriguing issues. The unconventional monetary policies involved, which sprang up quite recently in the developed countries, were unprecedented and have had powerful repercussions on the markets, even though the magnitude of these effects is still in question. This makes analysis uncertain.

While reducing central banks’ balance sheets could have adverse effects on stock and bond markets, in the case of the Fed it is clear that its early guidance and the modest scale of its plans are meant to smooth out these repercussions. Central banks have chosen to move despite prevailing economic conditions but it is likely their attitude will reassure markets as it guarantees a gradual approach and even the possibility of reversing course if necessary.

We therefore regard central banks’ treatment of their assets—treatment that up to now has buoyed the markets and will henceforth become slightly negative— as a change of direction that may cause volatility but should not change the playing field fundamentally.

 

Benjamin Melman
Head of Asset allocation and Sovereign Debt
Edmond de Rothschild Asset Management

 


This analysis is an extract from the first House View published by Edmond de Rothschild. 

This publication presents Edmond de Rothschild’s key convictions for macroeconomics, asset allocation strategy, and the principal asset classes. 

Access the other analyses presented in this publication: 

 

 


DISCLAIMER

This brochure was prepared by Edmond de Rothschild Asset Management (France). The following entities, including their branch offices and subsidiaries, limit themselves to making this brochure available to clients: Edmond de Rothschild (Suisse) S.A., located at 18 rue de Hesse 1204 Geneva, Switzerland, subject to the supervision of the FINMA, Edmond de Rothschild (Europe) S.A., located at 20 boulevard Emmanuel Servais, 2535 Luxembourg, Grand Duchy of Luxembourg, and subject to the supervision of the Luxembourg Commission de Surveillance du Secteur Financier (CSSF), and Edmond de Rothschild (France), Société Anonyme governed by an executive board and a supervisory board with a share capital of 83 075 820 euros – RCS Paris 572 037 026, located at 47 rue du Faubourg Saint-Honoré 75008 Paris.

This document is non-binding and its content is exclusively for information purpose. Any reproduction, disclosure or dissemination of this material in whole or in part without prior consent from the Edmond de Rothschild Group is strictly prohibited.

The information provided in this document should not be considered as an offer, an inducement, or solicitation to deal, by anyone in any jurisdiction where it would be unlawful or where the person providing it is not qualified to do so. It is not intended to constitute, and should not be construed as investment, legal, or tax advice, nor as a recommendation to buy, sell or continue to hold any investment. Edmond de Rothschild Asset Management or any other entity of the Edmond de Rothschild Group shall incur no liability for any investment decisions based on this document.

This document has not been reviewed or approved by any regulator in any jurisdiction. The figures, comments, forward looking statements and elements provided in this document reflect the opinion of Edmond de Rothschild Asset Management on market trends based on economic data and information available as of today. They may no longer be relevant when investors read this communication. In addition, Edmond de Rothschild Asset Management shall assume no liability for the quality or accuracy of information / economic data provided by third parties.

Any investment involves specific risks. We recommend investors to ensure the suitability and/or appropriateness of any investment to its individual situation, using appropriate independent advice, where necessary. Past performance and past volatility are not reliable indicators for future performance and future volatility. Performance may vary over time and be independently affected by, inter alia, changes in exchange rates.

Edmond de Rothschild Asset Management refers to the Asset Management division of the Edmond de Rothschild Group. In addition, it is the commercial name of the asset management entities of the Edmond de Rothschild Group.

EDMOND DE ROTHSCHILD ASSET MANAGEMENT (FRANCE)
47, rue du Faubourg Saint-Honoré - 75401 Paris Cedex 08 - France
Société anonyme governed by an executive board and a supervisory board with capital of 11.033.769 euros AMF Registration number GP 04000015 – 332.652.536 R.C.S. Paris