Speaking of quantitative easing, as FT Alphaville just has in a neat scene-setter for a Tuesday speech by Bank of England governor Mervyn King, Andrew Smithers of Smithers & Co warns in his latest world market update that asset prices are likely to fall after central banks end their QE programmes.
Like others, Smithers argues that the rise in prices of shares, bonds and gold has been largely due to massive QE programmes in the US and UK, and the outlook for asset prices when this policy ends is poor. Altogether, he says, QE programmes have seen $800bn injected in the US and £120bn in the UK, equivalent to 5.3 per cent and 8.2 per cent of GDP respectively.
It seems likely, however, “that the impact of this massive monetary injection will last for some time after it ceases as, in the US at least, the positive impact on share prices seems to have started some 3 months after the easing began,” he adds.
Among other points, Smithers says:
● Banks remain unwilling and unable to lend. This will not change until they have raised vast amounts of new equity.
● The rise in the market provides an opportunity for banks to raise this equity, but governments are reluctant to speed the process which would take years at the current rate.
● QE has halted, but not reversed, in the US and continues in the UK. It brings two benefits. First, it boosts the economy through higher asset prices and, second, it probably sustains credit.
● An end to QE before credit expansion from banks is likely to precipitate a return to recession, damaging the equity market.
● An end after banks are ready to lend again is likely to cause falls in asset prices including shares, bonds, houses and gold. We expect non-financial companies and banks to be sizeable net issuers of equity over the next year or three and for this to put downward pressure on the US stock market.
● Corporate bond spreads over Treasuries are no longer much above average. But, corporate debt levels are at record high levels.
● The collapse of the asset bubble means that the risks of both deflation and inflation are high. The chances of a return to slow, steady and mildly positive inflation are low.
● We currently have deflation and the shorter term risk is that this intensifies.
● The longer term risk is inflation, as central banks are probably too optimistic about output gaps and trend growth rates and underestimate the problem of bottlenecks as the world economy is rebalanced.
And a final word on corporate bonds, where the spread between US corporate 30-year Baa bonds and Treasuries fall from nearly 6 per cent to 2.1 per cent as of end-September, 2009. Concludes Smithers:
With corporate debt at record high levels, this spread seems now more likely to widen than narrow. Corporate bonds are thus likely to behave at least as badly as government bonds. As nominal and real yields are low by historic standards, these prices, in the absence of central bank buying, depend on the economy remaining very weak. The stock market seems unlikely to maintain its level if the economy is very weak.
Related links:
Moving targets, QE edition – FT Alphaville
Footsie has more than QE – FT
US equities – Smithers on supply and demand – FT Alphaville