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Wall of money keeps markets buoyant

Inflation is not the enemy of central banks right now and their printing presses continue to run. Money creation look set to continue and government debts will rise.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

by
Charles Stanley

in Features

08.01.2021

There is uniformity amongst the leading central banks of the world that recession, not inflation, is the enemy. They are all offering ultra-low interest rates, substantial money creation and large bond-buying programmes for this year and beyond.

The world’s financial controllers accept the Japanese model for the time being. Governments will borrow substantial sums to provide a fiscal stimulus. Central Banks will keep short term rates around zero – and will buy up government debt to keep longer term rates lower as well.

The Banks are not particularly interested in rates of money increase, and accept the results of their policies will be fast money growth. Over the last year, we have seen 25% growth in the M2 measure of money supply in the US, 14% in the UK, and around 10% in Japan and the Eurozone.

Cheap money for governments

None wish to be seen to be directly lending large sums for very little interest to their government owners, but most are effectively doing so by buying the second-hand debts issued by states. The governments and Central Banks have needed to do so, to provide an offset to the collapse of economic activity in a number of sectors badly damaged by anti-pandemic measures. In order to subsidise companies that have lost turnover through lockdowns, and to help people with benefits where they have lost income from employment, states have needed to borrow huge sums.

The latest Federal Reserve Board minutes of their December meeting confirm that the US authorities want to promote a stronger economic recovery. They remain concerned about the damaging effects of the anti-pandemic measures – and plan to continue ultra-low interest rates and substantial money creation for this year and beyond.

The Fed has excelled itself since last March, throwing large amounts of new money into the US and world system to offset the deflationary impact of the closures. At the latest meeting, the Fed said it will continue offering dollars under its swap and repo facilities for foreign Monetary Authorities until the end of September 2021.

Lower for even longer

It suggests that the Fed funds rate will remain unchanged for a long time. It expects inflation to rise above 2% in a couple of years – and wants it to stay there for a bit to get the average closer to 2% after a period of low price rises. It reaffirmed plans to buy at least $80bn a month of Treasury securities and $40bn of mortgage backed paper. “All participants judged that maintaining an accommodative stance of monetary policy was essential to foster economic recovery and to achieve an average inflation rate of 2% over time,” it said.

Some commentators were disappointed the Fed was not more explicit about quantified triggers for changes of policy, nor more precise over volumes of purchases. The narrative of the Committee’s discussions implies they still intend to keep money easy and see no worrying inflation threat anytime soon.

It is more concerned about the real economy, and are watching output, sales and employment. It still runs its money judgements on the basis that there is a short-term fixed capacity in the economy – and currently the economy is operating well below that. That means money must be loose and credit available to boost employment and growth. It is true we need to watch out for any change of mood at the Fed over withdrawing support, and in particular, to monitor inflation where a shock rise could cause a rethink.

Japanification

If we look at the originator of current policy, we see the Japanese continuing to increase state debt and grow the balance sheet of the central bank. State debt to GDP is around 225%. The Bank of Japan is approaching owning half of that total, meaning that it already owns more state debt than annual GDP.

It has also on the way acquired more than 70% of the Japanese exchange-traded fund (ETF) assets, and substantial holdings in corporate bonds. Owing to the declining and ageing population, the propensity to save and the adequate capacity of Japanese industry, there has been practically no inflation during this extraordinary long period of printing yen and issuing debt. The more inflation-prone west with different demographics may not have the same latitude as Japan to follow this same policy year after year.

The Euro-area is working its way through the Pandemic Emergency Programme, which allows the ECB to buy up €1,850 billion of bonds. Purchasing can continue until March 2022, and reinvestment of repayments and income on the portfolio can continue until end 2023. The ECB has also recently extended its long-term refinancing operations until June 2022, eased the collateral requirements of banks needing credit and encouraged the commercial banks to lend more. The pace of asset purchases is €20bn a month. The UK Bank of England has a total permitted purchase programme of £895bn, reaching £745bn in June 2020.

This is a backdrop for investors to prefer equities to bonds, given the very low yields now on offer in the debt market. It is a world where commentators and analysts will look around for themes and sectors that they can claim are good value, because they have underperformed – or exciting value because they are in glamorous growth areas.

Currently, the recovery theme is still gaining traction – even though the underlying economies are in relapse thanks to the new wave of the pandemic. The confirmation of Joe Biden as President-elect and the likely wins of the Democrats in the Georgia Senate run-off elections imply that more government stimulus is on its way in the US, and a large green investment programme.

The Fed, like the other main central banks of the world, will get on quietly with financing all this at very low rates of interest. They will need to do so, as the pandemic is giving the northern hemisphere a nasty winter.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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