Monetary Trajectories: Converging On The US Policy Road Map
The Fed—with its proclivity for simple and intuitive language (note: tongue firmly in cheek)—has repeatedly spoken about the potential for a supposed “wealth effect” caused by quantitative easing. This is so-called trickle-down economics, in which asset price appreciation causes higher consumption, eventually leads to greater real investment. That’s the theory anyway.
In reality, the opposite is actually occurring. While ultra-low rates and high monetary activism have surely boosted asset prices, they have simultaneously discouraged saving and, ultimately, led corporations to resort to financial engineering to boost earnings, as opposed to capital investment.
Where then does quantitative easing (QE) work best? The issue need not be hideously complex. While QE is often seen as a targeted approach, the channel where it works best is in the revival of investor animal spirits. QE—and the wider business of central banking—has always been a confidence game.
Therefore, U.S. monetary policy is widely seen as the successful post-crisis model. While it didn’t work as designed, it did engineer an upsurge in investor confidence.
This is why recent policy shifts in Europe have been so important. Overriding the political and philosophical opposition emanating from Germany (read: abandoning austerity and adopting QE) was everything. It means Europe has embraced the U.S. policy road map pioneered by Bernanke and Yellen. This was previously unthinkable.
Looking ahead, investors will start rewarding U.S.-style expansionary policies in the form of higher asset prices (whether one agrees with them or not is unimportant). This is already happening, with eurozone stock markets vastly outperforming the U.S. since the onset of QE. Expect this to continue.
Behavioral Indicators: US Dollar Sentiment Blinking Red
Everyone knows the euro is plunging to parity. Even French President Hollande recently joined the chorus, lightening the deflationary mood with his own joie de vivre: “It makes things nice and clear: one euro equals a dollar.”
But beware consensus forecasts. Our sentiment models are indicating near universal bullishness to the U.S. dollar. When everyone is thinking the same thing, who is left to place the marginal trade? Yes, the U.S. dollar could continue to strengthen into the stratosphere, but there is a high likelihood that several currency pairs stabilize, or even rally, from these levels.
The catalyst will be changing macro narratives. For the eurozone and Japan, capital will head back to these regions if a recovery takes hold. The resulting flows of global capital will at least stabilize the euro and yen.
Better yet, Asian currencies—which have been fairly resilient versus the U.S. dollar—could start to rally as a firm recovery materializes. Here the plunge in commodity prices is dramatically lowering inflation, paving the way for significant policy easing (six central banks in Asia have surprised with rate cuts this year). Perhaps more importantly, most Asian countries do not face the same liquidity traps as the developed world. Engineering a recovery by boosting domestic demand will be much easier.
In many ways, the above argument is not driven by a negative view on U.S. equities or the U.S. dollar. After all, history has shown that the senior currency becomes chronically strong in postfinancial crisis periods. This could still run for several years.
However, trends are not always linear. A pause is very likely. This will be driven by a recognition that worldwide policy is converging on the U.S. model and should deliver, at the very least, a multiquarter bounce in economies outside the U.S.
It is also a recognition that the sponsorship of rising global asset markets by the world’s monetary authorities will continue for some time. Still, it is time to rotate away from America. Thank you Bernanke and Yellen. Our clients have enjoyed the ride.
Tyler Mordy, president and co-chief investment officer of Hahn Investment Stewards, is an expert in the design and application of global macro ETF managed portfolios. He is interviewed by the financial media for his global investment strategy views, as well as ETF trends. CNBC has called him one of the “best independent ETF experts.” Contact Hahn athahninvest.com/contact.