Growth is better but issues remain

This article is part of
Autumn Investments Monitor - September

Growth is admittedly better, as the ripple-effects of loose policy allow G5 economies to claw-back their output lost.

However, it’s a slow grind, with the UK and eurozone half way to a ‘lost decade’. Middle East tension offers extra support to relative safe havens, such as UK gilts.

Markets sensitised to ‘taper-gate’ and not the euro are worrying about the wrong thing.

With demand-inflation tame and the ‘tool box’ empty, the G5 are still too vulnerable to be taken fully off their policy steroids. Which means, with more cheap cash looking for a home, growth and inflation assets should remain supported.

A bright spot is that the G5 is growing again. The second quarter saw the first in-tandem quarter-on-quarter rises in real GDP for almost two years, with even the eurozone interrupting its 15-month recession. This is encouraging, but owes much to base-effect in the eurozone, and special factors such as Japan’s weaker yen and UK housing support.

In policy terms, the G5 had in-tandem growth at the end of 2009 too, which quickly ebbed away once quantitative easing (QE) was switched off. More convincing has been the US, which, led by the private sector, stands 4.5 per cent up in real-GDP terms from its pre-crisis peak. Ex-government, US GDP is growing 2.5 per cent year-on-year, versus 1.6 per cent year-on-year with it.

Central banks therefore remain attuned to an only two-speed recovery – with the ‘dollar bloc’ (US, Canada, Australia) outperforming Japan and Europe. Which is why, with the toolbox empty, central banks will have to keep QE running, in spite of its patchy success in generating inflation and supporting activity.

Abenomics aside, it’s inevitable the pace of QE will slow. Fears of the US Fed ‘tapering’ its stimulus have already sparked a 1994-style lurch in developed and emerging market bond yields.

The near-term implications may be limited. Tapering is a further loosening in conditions; it could maintain the Fed’s share of net new issuance; and be reversed if the recovery ebbs. Ben Bernanke’s possible successor, Janet Yellen seems even more dovish.

It is telling how quickly international central bankers have distanced themselves from ‘taper-gate’. Forward guidance is an experiment that could backfire if credibility is stretched. In which case, QE will be switched on again, which questions the doomsters’ call for an imminent end of the ‘bull run’ in bonds.

Guidance could become impotent if certainty that rates in, say, three years’ time, are likely to be as low as they are today, simply defers [future] purchases. This gets us into the realms of ‘a Japan’.

As does the likely reluctance of central banks with ‘skin in the game’ to stop being the biggest bond buyers. With the Fed, for example, holding 25 per cent of US treasuries and the single biggest buyer, it’s unlikely to want to take markets off-guard.