Central Bank Hawkishness Under Pressure
In recent years, reputations of central bankers came close to deitylike status. While many investors rightly recognized unsustainable global imbalances and the reality of slow growth, they also respected the “central bank put.”
But how long can this reverence for the world’s monetary priests last? An, is the modern monetary toolkit a work of divine brilliance, or are they truly “making it up as they go along”?
With the Fed dithering over miniscule rate hikes and the European Central Bank fumbling around with a motley crew of policy tricks, the central-banker image may indeed suffer an irreparable blow. The priesthood, after all, is fallible. Yet central banks have become the lead sponsors of rising asset prices, effectively becoming victims of their own success. The Fed is now a creature of financial markets rather than a steward of the real economy.
Cushioning Volatility Creates Instabilities
Is this good? Of course not. Attempts to cushion the volatility always end up creating instabilities in the future. Yet seven years after the financial crisis, here we are.
In the run-up to the Fed rate decision in December, many observed that stock markets continue to rise for some 12-18 months even after hikes commence. However, that narrative was always suspect. Why? Because rummaging through postwar analogs yields no useful comparisons.
Exiting from the normal postwar interest rate regime is starkly different than retreating from a Mardi Gras of bank bailouts, low interest rates and quantitative easing. Recent criticism from Davos highlights the issue. While the IMF urged the Fed not to raise rates, it is now respected investor Ray Dalio who says, “There’s not a country in the world that should not ease its monetary policies.”
The central issue is that policymakers have not yet resolved the deficiency of world demand. That means we may have only scratched the surface in terms of unorthodox policy. The next stage will likely be central bankers endorsing higher budget deficits to sponsor infrastructure projects or even tax cuts. To be sure, these are all grubby policies but they are also widely supported—and wonderful for asset prices.
Fragilities Remain In Global Markets
We are closely monitoring the probability of another worldwide credit crunch.
Yet a more likely scenario is more of the same—a long period of slow growth, rising asset prices and further forays into unthinkable policy measures. And the end to China’s rapid industrialization era will continue to provide tail winds to the new leadership—including commodity-importing countries that have not been complacent about structural problems through the post-crisis era.
In this climate, investors should stay widely diversified with global ETF portfolios. That should always the first line of defense in managing volatility. After all, financial markets never promised to be boring.
Tyler Mordy, president and chief investment officer of Forstrong Global, is a recognized innovator in the design and application of global macro ETF managed portfolios. He is widely 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.”