ETF choices to offset deflation risks.
[This blog originally appeared on our sister site, IndexUniverse.eu,]
For all the column inches it has generated, the policy of quantitative easing (QE) has had little impact on the economy.
QE has undoubtedly helped boost asset prices since it was first introduced in 2010. The policy has raised the prices of the government bonds that are the focus of central bank asset purchases; and QE has clearly also pushed up the prices of credit instruments and equities.
But QE has so far failed to generate the kind of broad "wealth effect" that former Fed chairman Bernanke spoke of in 2010.
"Easier financial conditions will promote economic growth…lower mortgage rates will make housing more affordable and allow more homeowners to refinance…lower corporate bond rates will encourage investment…higher stock prices will boost consumer wealth and help increase confidence," Bernanke forecast when selling QE to the public.
What if the Fed, Bank of England and other QE-proponents haven't managed to banish deflation, merely to stave it off for a few years?
Quantitative easing has signally failed to push inflation measures substantially higher, despite an overwhelming consensus that it would do so when first introduced.
In the US, 5- and 10-year inflation expectations, as derived from the difference between conventional (fixed-rate) US Treasury bond yields and the yields on inflation-linked Treasuries (TIPS), are back to where they were at the end of 2011.
Instead, as consultancy McKinsey recently pointed out, QE has had more of a distributional effect, transferring wealth from the economy's savers to the highly indebted (in particular, to governments and to the recipients of state-sponsored pensions). In many countries, this is becoming an increasingly unpopular policy.
Meanwhile, headline inflation measures have been declining all this year: reaching 1 percent, year-on-year, in the US and 0.7 percent, year-on-year, in Europe.
In Europe, worse may lie ahead (that is, if you view deflation as bad news—governments do, but many don't).
The region's broad money supply is now perilously close to shrinking, as it did, briefly, in the aftermath of the 2008/09 crisis. The M3 growth rate is well below the ECB's 4.5 percent target. Loans to non-financial companies are now shrinking at an annual rate of 3.7 percent, with the decline approaching 20 percent a year in Spain. Year-over-year, prices are already falling in Ireland, Greece, Cyprus and Spain.
Sources: ECB, SocGen
So, far from being concerned about a tapering of QE programmes, should asset allocators now focus on the possibility of deflation?
Here are some ETF-focused portfolio ideas for a deflationary outcome in 2014.