We are drawing ever closer to the point when the world’s largest financial experiment, quantitative easing (QE), will be run down to zero.
Janet Yellen, Federal Reserve chairwoman, has suggested that economic data is sufficiently strong enough to continue tapering QE, with October appearing to be the month it finishes.
This will leave the US economy with ‘less loose’ monetary policy, but still benefiting from super low interest rates of 0.25 per cent federal funds, although policymakers have suggested that these will begin to rise in the second half of 2015.
Our own opinion is that interest rates should already be marching upwards in the face of a much better than expected recovery path and some signs that inflation is beginning to be less benign. But perhaps the outcome of QE was to generate inflation to erode the real value of debt anyway.
So, what happens next?
We would suggest that the bulls believe that QE has been a huge success, stimulating the economy to a degree that it is now robust enough to stand on its own feet. We have a great deal of sympathy with this view.
The bulls may also argue that if the economy continues to expand, then financial markets will benefit from additional consumption and the fabled capital expenditure will pick up. Here too we have some sympathy with the view, but where we disagree with the bulls is that the markets are well up with events already and we are really in the fifth year of a bull market.
The bears may suggest that QE was the only reason why markets have managed to go up so strongly, which is perhaps a too simplistic interpretation.
It may be more accurate to suggest that QE allowed all financial markets to rise at the same time, because the absence of sensible interest rates on cash induced investors to buy riskier assets in the hunt for yield. This seems more plausible to us. So if we expect QE to finish and super low interest rates to end, albeit slowly, then where are the real threats to investors’ capital?
Perhaps one answer to this could be the credit (corporate bonds) market. If investors are eventually able to return to cash accounts with real interest rates, then there is little need for taking risks with corporate bonds. While traditional corporate bond funds may be weakened, perhaps it is the vast money market funds industry that will be hit first.