Quantitative Easing on Turbocharge in Major Economies
In response to the global financial crisis and the muted growth that persists years later, central banks across the globe have aggressively expanded their balance sheets using a range of both traditional and unconventional policy tools. As of the end of June, the combined balance sheets of the U.S. Federal Reserve, European Central Bank and Bank of Japan totaled over $12.1 trillion — a 283% increase since June 2007. Never before have the balance sheets of the central banks of these major economies been so inflated.
Quantitative Easing on Turbocharge in Major Economies Central Banks in the U.S., Europe and Japan Have Expanded Balance Sheets
Sources: Federal Reserve, Thomson Reuters Datastream. As of June 30, 2016.
The table below summarizes the size and nature of their balance sheets and asset purchase programs.
Uneven Economic Recovery
Although this unprecedented level of stimulus resulted in double-digit asset price returns in the post-crisis period, it seems the markets are experiencing fatigue. Furthermore, asset prices have recovered much more quickly than global economic conditions. Despite the extraordinary efforts by central banks, global growth remains sluggish and inflation is generally running below policy targets. The euro zone is growing at an annualized rate of 1.7%, while Japan’s economy is growing at a pace of 1.9% as of the most recent readings. Inflation in Europe and Japan has, counterintuitively, continued to fall as the size of the quantitative easing programs has increased — in May declining 0.1% and 0.4% year over year, respectively.
It’s for these reasons that Europe and Japan have followed their Nordic counterparts in experimenting with negative deposit rates, although we would argue negative deposit rates are ineffective in achieving their intended goal. Muted growth has not been limited to advanced economies either, as emerging markets growth totaled just 4% in 2015.
Contributing to the subdued growth profile is a loss of momentum in China, the world’s second-largest economy, as the nation’s credit expansion continues to slow. While we don’t expect a hard landing in China, our expectation of sub-7% growth may continue to be a headwind for global growth.
Monetary policy is now experiencing diminishing returns and economic growth is weaker than it should be at this stage of a recovery. With monetary policy experiments — quantitative easing and negative rates — largely exhausted, developed-market policymakers will need to consider other alternatives such as fiscal stimulus in order to generate sustainable growth.
With its recently announced fiscal stimulus package, Japan is the first developed-market country to attempt to pass the baton from monetary to fiscal policymakers in the post-post-crisis period. The country’s recently announced ¥28 trillion (US$277 billion) fiscal stimulus package is equal to nearly 6% of its gross domestic product. Japan, however, has a checkered history of not following through on its announced fiscal plans, and it’s worth noting that only ¥7.5 trillion (US$73 billion) of real spending has actually been approved by Japan’s cabinet as of mid-August.
In the U.S., both presidential candidates have voiced a desire for increased infrastructure spending; income tax cuts and corporate tax reform are additional options that could be used to stimulate growth. While the lack of a central fiscal authority in Europe makes a coordinated effort more difficult, ideas for a fiscal response include infrastructure projects financed by the European Investment Bank, employment subsidies including lower
Asset Purchase Programs Have Dramatically Increased Central Bank Balance Sheets Although the U.S. Program Has Ended, Japan’s and Europe’s Purchases Continue
Sources: Federal Reserve, RIMES. Foreign currency converted to U.S. dollars at exchange rates as of June 30, 2016.
labor taxes, and education or training subsidies for individuals. Whatever its form, meaningful fiscal stimulus, alongside ongoing accommodative monetary policy, is likely the next stage in attempting to stimulate global growth, as monetary policy alone has not accomplished its original goals.
The success of fiscal reform will depend on how, and how much, fiscal response is implemented. Real structural reforms may ultimately be needed in these countries — especially in Japan, where serious issues related to demographics remain a drag on growth. We view labor market and immigration reform, as well as further integration with the rest of the world through trade, as necessary in Japan. While we believe Europe should focus its efforts on creating a real single-market economy, protectionist actions like the U.K.’s “Brexit” referendum to leave the European Union make a structural solution in Europe more difficult.
1 Dobbs, Richard, Tim Koller, Susan Lund, Sree Ramaswamy, Jon Harris, Mekala Krishnan, and Duncan Kauffman. Diminishing Returns: Why Investors May Need to Lower Their Expectations. McKinsey Global Institute. May 2016. http://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-investors-may-need-to-lower-their-sights
2 Bureau of Labor Statistics
3 S&P Dow Jones Indices
4 As of June 30, 2016. Data represents the percentage of debt in the J.P. Morgan Global Government Bond Index (GGBI) yielding less than the 10-year U.S. Treasury. The GGBI is composed of the sovereign debt of the following developed-market countries: United States, Japan, United Kingdom, France, Italy, Germany, Spain, Belgium, Netherlands, Australia, Canada, Denmark and Sweden. In the calculation of this statistic, all U.S. Treasuries have been excluded from both the numerator and denominator.
5 As of June 30, 2016. Data represents the percentage of debt in the J.P. Morgan Global Government Bond Index that has a negative yield.
6 For retirement accounts that do not benefit from the tax-exempt status of municipal bonds, a lower portfolio yield, around 2.5%, should be targeted.
7 The Morningstar Short-Term Bond Category had a yield to maturity of 1.8%, while the Morningstar Muni National Short Category had a tax-equivalent yield to maturity of 2.8% as of 5/31/16. Morningstar does not calculate yield to worst for its bond categories, which is generally lower than yield to maturity. Tax-equivalent rates are based on the top 2015 federal tax rate of 43.4%, which includes the 3.8% Medicare tax. The reader’s portfolio yield target should be adjusted according to their respective tax bracket.
8 Based on the Bloomberg Barclays Aggregate Index yield to worst value of 1.9% and tax-equivalent Bloomberg Barclays Municipal Bond Index yield to worst value of 2.8%, as of 6/30/16. Tax-equivalent rates are based on the top 2015 federal tax rate of 43.4%, which includes the 3.8% Medicare tax.
9 The Morningstar High Yield Muni Category had a tax-equivalent yield to maturity of 7.9% as of 5/31/16. Morningstar does not calculate yield to worst for its bond categories, which is generally lower than yield to maturity. Tax-equivalent rates are based on the top 2015 federal tax rate of 43.4%, which includes the 3.8% Medicare tax.
10 Five-year correlations to the S&P 500 of Bloomberg Barclays Municipal Bond Index and Bloomberg Barclays Municipal High Yield Bond Index were–0.17 and 0.06, respectively, as of 6/30/16.