Two decades on from Japan’s first foray into QE, the nation’s leaders are still battling to wrestle the economy from the grip of chronic recession risks and deflation dangers - and they remain a long way off from normalising policy. It has been a long hard battle and it is not over yet.
There
must be many central bankers from leading industrial countries suffering acute night
terrors, wondering how to retreat from zero interest rates and the explosion of
QE-led bond buying since 2008 that has left them with an unfathomable puzzle. That
is, how to reduce the dependency on super easy monetary accommodation without
damaging growth?
This week, the US Federal Reserve will attempt to do just that when it finally lifts interest rates after seven long years at zero per cent. The Fed has decided the time is ripe to begin the return journey to neutral interest rates somewhere around the 3 to 4 per cent mark.
The second leg of ‘mission impossible’ comes later on when the Fed starts disposing of its huge 4-1/2 trillion dollar stockpile of QE assets. There is no date fixed for that yet, but the Fed probably wants to put it off for as long as possible. It could wreak a terrible toll on the global economy and world financial markets.
The world can do without more turmoil. Since 2008, the global financial crisis has already been through three disastrous phases. The credit crunch in the US and UK, Europe’s sovereign debt crisis and more recent emerging market mayhem have all left global confidence in a precarious state. There may be no easy way back from a ‘fourth wave’.
When the Fed eventually pares back its over-bloated balance sheet, global liquidity will feel the pinch. So too will global asset markets which have been kept afloat by vigorous QE pump-priming for the last seven years. Investors who have indulged in cheap, easy leverage will suffer severe withdrawal pains as rates go up and liquidity is squeezed.
There
will be no easy fix. Markets are already bracing for the dawn of tighter money
this week, while the global economy is showing worrying signs of fatigue. The
US and UK economies are losing vital momentum, the euro zone is mostly struggling,
China is slowing down and Japan has just avoided another technical recession.
Emerging economies remain at risk.
The
continuing collapse in global commodity and oil prices reveal disturbing cracks
in the world economic outlook. The drop in crude oil prices to the lowest
levels since 2008 is symptomatic of a growing shortfall in global demand as
economic activity slows up.
The aftermath of the global financial crisis is still being felt. Balance sheet restructuring, debt-deflation and austerity cutbacks are casting dark shadows over world economic confidence. Consumer, business and investor optimism remains skittish and the spectre of rising US interest rates could be the tipping point for another major market meltdown.
The Fed is clearly being blinded by glowing US employment numbers, with the US jobless rate back to pre-crisis levels. But it is important to remember unemployment is a lagging not leading indicator. There are still weak links in the US economy and the global backdrop remains deeply unsettled.
World trade has already shrunk 15 per cent from levels a year ago. Global growth projections continue to be downgraded by leading forecasters like the IMF and OECD. World economic sentiment remains balanced on a knife edge.
If the Fed miscues and global confidence goes into knee jerk reverse, there is little to stand in the way. The world’s policymakers have run out of easy options. The global economy is building resistance to new QE initiatives and there is precious little fiscal slack left while governments continue to cut budget deficits and slash debt.
Global equity, credit and bond markets could easily be swept up into the mother of all ‘taper tantrums’ if the risk-off mentality gets a firmer grip. The danger is global policymakers will end up hapless bystanders without a cure.
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