Last month the Fed announced the much-anticipated third round of quantitative easing (QE3), stating it will buy $40bn of agency mortgage-backed securities every month (with no stated end-date) and will keep the fed rate close to zero out to at least mid-2015.
In addition, the ECB announced potential “unlimited” sovereign bond buying (with strict conditionality) and Germany approved the European Stability Mechanism (ESM). Japan and Australia have also stepped up their monetary easing.
The next step is for Spain to formally ask for a Europe/IMF bailout (and the conditionality it will entail) as it will permit the ECB to move ahead with direct purchases of bonds if and when necessary.
The moves have boosted risk appetite, however global growth continues to slow and a number structural problems remain unresolved.
Global growth continues to slow
Despite substantial monetary stimulus, the US jobs market and most growth data are still sluggish.
There have, however, been tentative signs of improvements in the US housing market and the US services and manufacturing ISM, with the latter rising out of contractionary territory to 51.5 in September.
US payroll figures have recently improved with NFP rising to 114K and unemployment falling to 7.8% in September, a 3 year low. However, payrolls increases consistently above 200k are necessary to have a lasting impact on unemployment.
Eurozone economic activity continues to deteriorate, with most countries in recession.
China’s economy has slowed, but with GDP growth of 7.6% in 2Q 2012, it is far from recessionary territory. China’s authorities are now reacting strongly, cutting bank reserve requirements, easing credit controls, increasing infrastructure spending and reducing interest rates.
While the growth moderation may continue in the near-term, the substantial fiscal and monetary resources available should help support growth in 2013.
The debt crisis in Europe: no easy solutions
Spain’s recession continues to deepen and its deficit continues to widen. Deteriorating regional government finances may be the factor that pushes Spain over brink and forces it to accept a bailout package.
A positive development is that recently the Spanish finance minister outlined an austerity budget that would slash spending by 8.9% and introduce a number of structural reforms that are in line with potential bailout terms outlined by the EU. This would permit the ECB to move ahead with direct purchases of Spanish sovereign bonds if and when necessary.
While policy appears to be becoming more coordinated and liquidity conditions are improving, Europe’s debt burdens remain large and the fiscal drag on growth will remain in place for the foreseeable future. This will keep the onus on the ECB to maintain a highly accommodative monetary policy.
Some optimism of ECB bond buying plan and Fed QE3
Italian and Spanish yields fell sharply after the ECB pledged to carry out unlimited bond purchases, but they soon started rising again on comments from Spain’s authorities they do not plan to take a bailout in the near term.
If bond yields rise much further it is likely they will be forced to take the bailout sooner rather than later. If Spain accepts a bailout package, bond yields will likely fall again as it will open up potential “unlimited” buying by the ECB. This may spark a renewed risk asset rally.
Tentative optimism has seen investors begin to unwind defensive positions in German and US government bonds after yields reached record lows in mid-June. However, weak economic growth, easy monetary policy and the euro zone debt crisis has kept demand for safe havens such as gold strong.
Central banks will continue to increase liquidity until economies recover
In order to support financial markets and encourage economic growth major central banks will need to continue to embrace expansionary monetary policy.
On 13 September the Fed announced the much-anticipated 3rd round of quantitative easing (QE3), stating it will buy $40bn of agency mortgage-backed securities every month (with no stated end-date) and will keep the federal funds rate close to zero out to at least mid-2015.
The Fed made very clear that they will do whatever it takes to bring US unemployment down.
The ECB’s long-term refinancing operation (LTRO) and other liquidity provision has substantially increased the ECB’s balance sheet. The ECB’s approval in early September of a new (sterilized) unlimited bond buying program for
European sovereign bonds paves the way for further monetary expansion.
If Spain formally asks for a European/IMF bailout, the ECB will be allowed to undertake “unlimited” purchases of its sovereign bonds.
The BOJ has upped its asset purchase program and eased the way for negative bond yields.
Long-term structural demand remains commodity supportive
Despite near-term uncertainties, long-term structural factors remain supportive of commodity prices.
The continued industrialization and increasing wealth of large population developing economies such as China and India are supporting long-term commodity demand. Supply remains constrained and increasingly difficult to access, pushing commodity prices higher.
If E.M. per capita commodity consumption follows the development pattern of OECD countries, when combined with their large populations, the potential future demand for oil and other commodities may be immense.