by Hans-Jörg Naumer, Allianz Global Investors
Summary
As the global economy continues to muddle through, the days of easy monetary policy may have peaked – along with the period of ultra-low yields. We may begin to see changing policies as central banks re-evaluate, which could lead to jittery markets.
Monetary policy will be back in full force in September. It will start with a meeting of the Governing Council of the European Central Bank (ECB) during the first week of the month, at which macroeconomic projections will be presented; this meeting will be followed in close succession by meetings of the US Federal Reserve and the Bank of Japan in mid-September. The Bank of England and the Swedish and Russian central banks will also meet in the middle of September.
By the end of 2017, the Fed is likely to start reducing its portfolio of US Treasuries and mortgage-backed securities through a previously announced procedure in which it will reduce the amount of the proceeds from maturing bonds that it reinvests. We expect the Fed to reduce its USD 4.5 trillion balance sheet by approximately one half over the next few years.
The ECB may not be in such a hurry, but it will also face a time of reckoning. Given the economic upturn in the euro zone, it is becoming increasingly hard for the ECB to justify its expansionary policy. The projected economic trend could prompt ECB President Mario Draghi to give the long-awaited signal for tapering (a gradual reduction in bond purchases). This would be the perfect time to do so, since Germany’s foremost protector of the constitution, the Federal Constitutional Court, has referred a case on the ECB’s asset purchase programme (quantitative easing) to the European Court of Justice for review on the grounds that it violates the ban on using the central bank’s deep pockets to directly finance governments. And no wonder. In the case of Germany and Portugal, the ECB is already buying up almost one-third of new issues. The Eurosystem’s balance sheet has almost quadrupled since 2007. As for the sequence of the withdrawal, the ECB’s Governing Council will presumably adhere to its current guidelines. In other words, a “QE exit” will likely come before interest-rate hikes. As a result, the first step in this direction is not expected until later in 2018.
While the Bank of Japan is likely to continue to pursue its expansionary policy, central-bank liquidity in aggregate could peak in 2018. In that case, the peak liquidity flood could also turn into the peak of “financial repression”. This has been a phase of unnaturally low – indeed, in many parts of the world, negative – yields on top-rated government bonds during which investors unwillingly have helped finance ministers reduce government debt. As financial repression abates, it certainly does not mean that in the foreseeable future government bonds will offer decent returns again – even after deducting the loss in purchasing power (ie, inflation). The hunt for returns should continue, even though yields should peak.
And don’t forget: Geopolitics could also provide an excuse for the monetary authorities to wait for a while before beginning the descent. However, the closer we get to descending from the peak, the more uneasy the markets will become.
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Hans-Jörg Naumer
Hans-Jörg Naumer is Global Head of Capital Markets & Thematic Research with Allianz Global Investors which he joined in 2000. The focus of his work is on analysis relating to strategic and tactical allocations, specific investment opportunities and the identification of long-term investment trends. Before joining the firm, he worked for Société Générale, where he became the Head of Research Germany and was part of the French investment bank’s international research team. From his vantage point as an analyst and economist, he observed the establishment of the Economic and Monetary Union and thus ranked among the prime “ECB Watchers”. He started his professional career in the corporate banking division of Deutsche Bank in 1994. Hans-Jörg studied economics at the University of Mannheim, one of the leading universities for economics and business studies in Germany. During his studies, he worked at the Chair for Macroeconomics.
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