Leave it to the world’s central bankers to bring an abrupt end to the lazy days of summer. First we had the U.S. Federal Reserve’s annual Jackson Hole gathering in late August, where the rock stars of monetary policy—Fed Chair Janet Yellen and European Central Bank President Mario Draghi—hit the stage amid the twin pyrotechnics of easy money and a vision of the future where every worker has a job. Then, Dr. Draghi promptly delivered on his promise to add stimulus to the euro zone economy with lower interest rates and asset purchases. His action came as Japanese Prime Minister Shinzo Abe used a cabinet reshuffle to show he has not given up on Abenomics just yet.
Heading into fall, the promise of more easy money bodes well for equities and bond prices. The recent high of the New York Stock Exchange Advance-Decline Line supports this optimistic hypothesis, suggesting that stock prices will continue to reach new highs.
The big headlines as investors returned from summer vacations have been about Dr. Draghi delivering on quantitative easing with plans to purchase asset-backed securities and covered bonds. There is debate about whether the ECB’s actions amount to QE or not, but if it walks like a duck and quacks like a duck, it’s a duck. Dr. Draghi deserves credit for clearing the path toward quantitative easing in Europe—no mean feat considering the skepticism that has been emanating from some quarters.
In addition, the ECB has cut its main lending rate by 0.10 percentage point to 0.05 percent, and cut the rate on bank deposits further into negative territory, to -0.2 percent from -0.1 percent. More negative deposit rates should encourage commercial banks to take reserves out of the ECB and put them into the economy rather than pay to park bank deposits at the ECB.
Foreshadowing Dr. Draghi’s actions was dismal data from Europe’s largest economy. According to Germany’s Federal Statistical Office, German second quarter GDP contracted 0.2 percent. As goes Germany, so goes the euro zone, where inflation has fallen to 0.3 percent (its lowest level in five years) and manufacturing is struggling.
Help from Japan
It’s not just Europe that could add stimulus. Bank of Japan Governor Haruhiko Kuroda faces similar pressures as Japan’s economy has failed to rebound after a sales tax hike prompted the sharpest economic contraction since the start of 2011.
And recently Dr. Abe appointed Yuko Obuchi, the daughter of a former premier, as Japan’s
first female trade and industry minister. It may not quite be the third arrow of Abenomics but it’s certainly a dart and it hit the bull’s eye. The symbolic value of appointing a record number of female ministers—five in all—sends a profound message to Japanese society that Abe is serious about growing the workforce by increasing the participation rate among women in the available pool of labor. Getting more women into the available labor pool is a critical component of the third arrow, which will raise potential for economic growth. This may well signal a major cultural shift in Japanese society, where women tend to be underrepresented in leadership roles, and it certainly has broken the glass ceiling. We are in the very early days of what I think will be a fundamental restructuring of the Japanese economy. In the words of Bob Dylan, “The Times They Are a-Changin.”
In the United States, I expect the Fed’s band will keep playing its merry tune for the near future. Dovish voting members of the Federal Open Market Committee will rule the roost even more in 2015. With the labor market improving and after nearly six years of ultra-easy Fed policy, hawkish members of the FOMC have increasingly made the case for higher interest rates sooner. However, while these hawks generate a lot of headlines, they are a minority among voting members, occupying just two of 10 spots. Next year, as the debate over rate hikes becomes more prominent, the annual rotation in voting FOMC members will further weaken the hawks and bolster the doves. This suggests that the risk lies with later rate increases, not earlier.
FOMC HAWKS AND DOVES
If the Fed hikes short-term U.S. interest rates next year, it will probably take two or three more years before we reach the point of a recession. We still have a long runway left. That tells investors that all the noise about credit bubbles and credit spreads being too tight is just not that big of a concern.
The world’s central banks will be doing whatever is necessary to keep their economies from falling into depression or any other economic malaise. Some investors are preoccupied with QE going away, but internationally it is ramping up and that bodes well for equities and for bond prices this fall. So not to worry: From what we heard at Jackson Hole and in the weeks that followed, the world is awash with liquidity and the easy-money band won’t stop rocking.
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