Global
Strategic
Outlook
Has monetary policy
ultimately become too loose?
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UPDATE II/2016
GLOBAL STRATEGIC OUTLOOK
Globally, central bank rates remain stubbornly close to
all-time lows averaging 0.5% in advanced economies and
2.2% including emerging markets.
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Thanks to the rise in oil prices inflation rates
have started to increase to a global average of
AUTHOR: STEFAN HOFRICHTER
In December 2015, the US Federal Reserve (Fed) finally raised
interest rates for the first time since 2008 when rates were
reduced to virtually 0%. However, other major central banks,
notably the European Central Bank (ECB), the Bank of Japan
(BoJ) and the Swedish Riksbank, lowered rates further. Indeed,
the BoJ joins the ECB, the Swedish Riksbank, the Danish National
Bank and the Swiss National Bank in testing the waters with
negative central bank rates. The ECB, along with the central
banks of Japan and Sweden, has also indicated a further
expansion of its quantitative easing policy: all three banks
have planned higher liquidity injections into their respective
markets. Emerging markets are not immune to these
problems and several emerging market economies have also
cut interest rates including India, Indonesia, Poland and
Hungary.
While communications from the Fed (e.g. via quarterly updates
of its famous “dot charts”) suggest further rate hikes are likely
this year, market expectations point towards only one more
rate hike and that too with a probability of 50%. Likewise,
expectations of the first Bank of England (BoE) rate hike have
been pushed back further into the future. The markets are not
ruling out a rate cut, as the next likely step by the “Old Lady on
Threadneedle Street” either. So nine years on since the Great
Financial Crisis, and global monetary easing continues with no
end in sight.
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UPDATE II/2016
GLOBAL STRATEGIC OUTLOOK
process of policy normalisation. This is particularly true for the
Fed, which has been most explicit in pointing to the impact of
international developments on its monetary policy and interest
rate decisions.
We have to ask ourselves:
· Is further easing actually required?
· What are the major costs associated with the current stance
in monetary policy?
· Has monetary policy become too loose?
Inflation: less bleak than at the beginning of the year
Inflation data, too, look less bleak than at the beginning of
the year. Thanks to the rise in oil prices – the key driver for
headline inflation in the near term – inflation rates have
increased to a global average of 1.8%. Core inflation, while
marginally down since January of this year, is still hovering at
around 2% globally. This is around its highest level since the
beginning of the decade, despite GDP levels that are lower than
they were pre-crisis. Following years of under investment in the
developed world, notably in research and development (R&D),
productivity growth has come down. Consequently, potential
growth rates are lower than they were before the Global
Financial Crisis; output gaps are narrowing (or have already
closed). Core inflation rates, meanwhile, are edging up, despite
disappointing economic activity compared to pre-2007. Even
though long-term inflation expectations measured by surveys –
as opposed to markets – have edged lower during the last two
years, in both the US as well as in Europe, they remain at around
the target levels set by their central banks. This is important
because if prices were expected to fall, consumers and
companies would be inclined to postpone spending, thereby
There is no doubt that global economic growth continues to
be lacklustre. Data from the developed world showed growth
edging down towards the end of 2015 and during early 2016
following turbulence in emerging markets last summer. Our
own forecasting tools suggest economic growth is, nevertheless,
likely to be at around potential in the developed world (i.e. slightly
below 2% in the US and slightly above 1% in the euro area in real
terms).
We have also received the first tentative positive economic data
out of emerging markets, including China. Even more importantly,
the massive capital outflows from emerging markets, especially
during the summer of 2015, which were at the root of the sharp
rise in volatility in capital markets, have lost momentum and in
some cases probably stopped. Central banks in the West have
repeatedly highlighted potential spill over effects from emerging
markets (read China) to their respective economies. So any
improvement in economic data in emerging markets may actually
relieve some of the pressure to further ease or to postpone the
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01 INCRE ASING INCIDENCE OF FINANCIAL CRISES AND ASSET BUBBLES SINCE THE END OF BRET TON-WOODS
Share of countries in crisis since 1900
Percentage points
S&P 500
60%
10,000
50%
1,000
40%
30%
100
20%
10
10%
0%
1
1900
1910
% of DM in crisis
1920
1930
% of EM in crisis
1940
1950
1960
int. monetary system
regime change
1970
1980
1990
2000
2010
S&P 500
Sources: Allianz Global Investors; Datastream; Schularick, M. und Taylor, A. M. (2009): “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crisis, 1870–2008”;
L.Laeven and F.Valencia:, IMF WP/08/224 “Systemic Banking Crisis Database”; definition of crisis years according to Schularick/Taylor (1900-2010) and Laeven/Valencia (1970-2008);
own estimates for years since 2008
DM: G7, Australia, Denmark, Norway, Spain, Sweden; EM: Argentina, BRICS, Chile, Hong Kong, Hungary, Indonesia, Israel, Korea, Kuwait, Malaysia, Mexico, Philippines, Poland, Singapore,
Thailand, Turkey
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Year
UPDATE II/2016
GLOBAL STRATEGIC OUTLOOK
driving down demand in the economy. In sum, economic
activity and inflation dynamics, while far from splendid, do
not necessarily suggest that more monetary stimulus is
warranted. We think there is scope to start the process of
policy normalisation.
· Firstly, if the yield curve flattens substantially as a
consequence of bond purchases by central banks, the
profitability of the banking sector will suffer and hamper
it ability to lend. Indeed, the net interest margins of US
and European banks have declined steadily over the
past two years.
Moreover, recent stimulus measures implemented by the ECB,
BoJ and Riksbank have not weakened the Euro, Yen or the Krona
respectively. On the contrary, all three currencies have since
appreciated. Markets seem to have lost faith in the magical
powers of central banks and their ability to stimulate growth
especially as the potential effect of the banks’ continued policy
easing has been offset by the ‘beggar-thy-neighbour’ policies
of other central banks.
· Secondly, negative central bank deposit rates, currently in
place in countries representing around one quarter of the
world’s GDP, are particularly detrimental to a banking system
largely dependent on retail deposits. For political reasons, it is
not possible to pass on negative deposit rates on reserves
held at the central bank to retail customers by cutting interest
rates on deposits into negative territory. Negative deposit
rates therefore simply drive up costs for banks and reduce
their profitability. As the ECB’s most recent lending survey
shows, negative interest rates will become a serious concern
for the banking system in the euro area if the current rate
environment persists for much longer.
There are other reasons to argue that the monetary policy
being pursued by central banks in the developed world may
have become too loose. Most importantly, changes in monetary
policy will have limited effect on economic growth if weaker
growth compared to the pre-crisis period is due to weak
aggregate supply rather than low aggregate demand. Of course,
effective monetary policy measures can still help stimulate
investment activity, but these alone will not guarantee a rise
in potential growth rates. A strong monetary policy must
be accompanied by structural reforms designed to enhance
productivity as well as labour growth via rising labour
participation or immigration.
Ultra-easy monetary policy may also feed new excessive credit
booms. As capital mobility has risen substantially since the
1990s – according to the Chinn-Ito index, global capital account
openness has increased significantly since the 1980s – loose
monetary policy has been exported to the rest of the world. The
pursuit of easy monetary policy by major central banks may
actually have contributed to strong credit growth outside their
jurisdiction. Indeed, post-2008 and following the massive
response of the Fed, ECB and BoE after the financial crisis, we
have observed a sharp rise in non-financial credit in countries
hardly, if at all, affected by the crisis in the emerging and
developed world. Chart 01
Financial Instability: risks on the horizon?
In addition, an ultra-easy monetary policy pursued for too long
may actually increase financial instability either by weakening
the banking sector or by facilitating the formation of credit
bubbles.
Leverage in the non-financial sector has reached all-time
highs and now stands at more than 230% of world GDP with
the private sector in emerging markets, especially in China,
The banking sector can suffer from the consequences of an
ultra-easy monetary policy in two ways:
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Leverage in the non-financial sector has reached
all-time highs and now stands at more than 230%
of world GDP.
being the main culprit. We estimate that non-financial private
debt in China has risen to more than two times GDP. This
number compares to 1.6 times GDP for the average of
advanced economies just before the Global Financial Crisis. It
is not only the level of debt that is worrisome, but also the pace
of its build-up. The credit gap, defined as the deviation of
private sector leverage from trend, has reached double-digit
levels in several economies, notably China, Brazil, Turkey,
Hong Kong and Singapore.
to fend off any major disruptions in the financial system.
However, it does suggest that credit growth has been too strong
in large parts of the world, notably emerging markets. This is
weighing significantly on the outlook for trend growth going
forward as banks may have to increase provisioning. Chart 02
Could these developments be linked to the ‘accommodative’
monetary policy stance adopted by central banks after the
Global Financial Crisis? Clearly, it is impossible to track money
flows and establish watertight causal relationships between
monetary policies being pursued in the developed world and
credit growth elsewhere. What we do know, though, is that
over the last 30 years or so, major central banks’ policy rates have
generally been below what is considered “neutral”, as derived
from trend nominal GDP growth. Furthermore, US monetary
conditions, as measured by the Chicago Fed Monetary
Conditions Indicator, have been quite favourable. And yet, the
last 30 years have been characterized not only by solid economic
activity around the world – real global GDP growth has averaged
3.5% since the mid 1980s – but also by ever more frequent cycles
of credit booms and busts.
Historically, we have seen that all major crises since the break-up
of the Bretton-Woods system were preceded by wide credit
gaps. The Great Financial Crisis of 2007/08; the Asian crisis of
1997/98; the Mexican (and Latin American) Tequila crisis of
1994/95 and the financial crisis in the Nordic region during the
1990s all shared the same marker. In the US too, debt levels in
the non-financial corporate sector have increased substantially
since the beginning of this decade – up almost 100% according
to bottom-up data for listed companies! This is not to say that a
new financial crash is around the corner. China, in particular,
with currency reserves in excess of USD3 trillion, has the means
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GLOBAL STRATEGIC OUTLOOK
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02 CENTR AL BANK R ATE S VS “NEUTR AL” LE VEL (= R ATE S REL ATIVE TREND NOMINAL GDP)
Percentage points
8
6
4
2
0
–2
–4
Year
1985
1980
USA
UK
1990
EMU
1995
2000
JAP
Sources: Allianz Global Investors Economics & Strategy, Datastream, Thomson Reuters; as of:27.04.2016.
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2005
2010
2015
UPDATE II/2016
GLOBAL STRATEGIC OUTLOOK
What are the implications for investors today?
Stefan Hofrichter has been Head of Global Economics and Strategy Group at
Allianz Global Investors since 2011. His research activity focuses on the areas of
global and European economic development, asset allocation and equity strategy.
He joined the company in 1996 as a European equity portfolio manager. Since
1998, he has been working in the field of macroresearch. Between 2004 and 2010,
he also managed European and global balanced funds, multi-asset-absolute-return
funds and multi-manager-alpha-porting funds. Stefan Hofrichter became a
member of the AllianzGI Global Policy Council, which determines the company’s
medium-term capital market assessments. Since 2013, he has also been a member
of the newly created investment committee for tactical asset allocation, which is
responsible for the investment strategy of the multi-asset mandates managed in
Europe. From 2010 to 2012, he chaired the Asset Allocation Committee for balanced
funds managed out of Frankfurt. Stefan Hofrichter holds a degree in Economics
from the University of Konstanz (1995) and in Business Administration from the
University of Applied Sciences of the Deutsche Bundesbank, Hachenburg. He
became a CFA Charterholder in 2000.
Easy monetary policy has generally provided a positive backdrop
for economic growth and risky assets, notably right after the
financial crisis. However, too much easing for too long also
comes at a cost. We should therefore take any further potential
stimulus measures with a pinch of salt. It will take more than just
a monetary stimulus to raise asset prices. In the long run,
reasonable valuations (for European equities as well as emerging
market assets); a regular income stream – an argument in favour
of dividend strategies and selective spread products and a solid
and stable growth outlook are more important. In addition, risk
management has to become an integral part of superior asset
management solutions in order to address the rising probability
of higher market volatility ahead.
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