I’ve spent a lot of this week pointing out that the conflict between the US and Iran is scary, but probably not that important for markets.So if geopolitical turmoil isn’t particularly significant for investors, what is? If tidings of war and promises of strife don’t matter, then what does? I hate to say it, but it’s the same old, same old – it’s all about how accommodating central banks plan to be.
You’ll often hear that central banks are “out of ammo” or that their effect on markets is overstated. Neither is true. Forget the “zero bound” – you can always make monetary policy looser. You just print it. And as long as you can get it out there – and central banks can – then it’ll go somewhere. It may or may not do much for the underlying economy. But when it comes to markets, as Eoin Treacy of FullerMoney puts it: “The simple fact is monetary policy beats most other factors most of the time.” So given that they’re so important, the question for investors is: what are central banks planning this year?
Let’s start in the UK. Andrew Bailey takes over from Mark Carney as governor of the Bank of England in March. What can we say about Bailey? He understands financial regulation, which will be handy during the Brexit talks. And he will hopefully be less “starry” than Carney.
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As for monetary policy – typically, the Bank of England takes its cue from the US. Yesterday, for example, Carney suggested that the Bank could commit to keeping rates low until inflation is clearly remaining around target – a so-called “lower for longer” strategy. He noted that there is still room to cut rates if needs be.
You might think he just wanted to give sterling another few kicks before he heads out of the door. But he’s really just echoing the general line of the Federal Reserve, America’s central bank. In all, it’s hard to see the UK’s central bank springing many surprises this year. And that’s no bad thing.
Look out for bank mergers in the eurozone
The European Central Bank (ECB) is more interesting. All central banks are political entities, of course, but the ECB is about to become much more overtly political.
The previous incumbent, Mario Draghi, lashed the eurozone together, over the misgivings of the Germans, with sticky tape and quantitative easing. It’s Christine Lagarde’s job to make that permanent.
The purpose of the euro was to make ever-closer union an inevitability. One benefit of Brexit for those who are in favour of a much closer union is that they now feel able to be much more explicit about that.
How might that manifest in monetary policy? Well, the whole point is that Lagarde probably won’t have to do much on that front, certainly not this year. Draghi set the ECB to auto-print before he left. Unless inflation in the region rockets for some reason, Lagarde can justify leaving it there.
She’ll continue to press national governments to spend more, dangling the carrot of ECB money-printing to underwrite spending on “green” tech. But what’ll be more interesting is to watch what happens in the eurozone banking sector this year. If progress is being made towards ever-closer union, that’s where it’ll start – with a load of mergers.
The policy response from Asia
What about the Bank of Japan? It hasn’t drawn much attention to itself in recent months. However, one point worth noting is that Japanese ten-year bond yields have quietly crept into (barely) positive territory in the last few weeks. The Bank of Japan will probably be quite happy about that – it wants a steeper yield curve, which is healthier for the banking sector.
As for China’s central bank – an increasingly important player – signs are that after tightening up in recent years (to impose a bit of discipline on lenders and borrowers), the People’s Bank of China is loosening monetary policy again. That will be cheered by markets.
The daddy of them all
Finally, the Fed. Ultimately the Fed is the one that matters. One reason that markets have been so exuberant over the Christmas period is that the Fed has not only backed away entirely from the idea of raising rates, but it is also injecting funds into the system to prevent liquidity from seizing up.
This isn’t quantitative easing (and I don’t think this is just semantics, it’s genuinely different). But it is keeping things ticking over and also reassuring all market participants that the central bank has their back.
The main problem for the Fed is that the US is irresistible. Everyone wants a piece of it, and that makes it hard to drive the dollar down, which to a great extent, is the key to getting a proper wild boom going.
Of course, the Fed probably shouldn’t be trying to spike the punch bowl right at this point in the cycle. But it is election year, so we know who’ll be jogging their elbows at every chance he gets.
In short, central banks are all in loosening mode. None of them is remotely concerned about a global economy that’s running at close to full employment, and they’re all apparently willing to ignore inflation until it’s firmly embedded in the system.
Given that, it’s difficult to be bearish overall. I’m sure I’ll find reasons to do so, and I’ll still favour cheap markets over expensive ones. But at the risk of repeating myself, the fundamental issue is this – until inflation takes off, there’s no reason for central banks to step back. And for as long as that’s the case, it’s hard to see why asset prices would collapse.
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