Of no fixed abode - PART I: QE and quo vadis

Abenomics. Draghinomics. Investor shock and monetary awe. This is the stuff insurance nightmares are made of. This is also the evolving macroeconomic reality that insurance companies inhabit.We live in a world of unconventional monetary policy, where economies cluster at the zero interest rate bound, and the ‘big four’ central banks – the US Federal Reserve, European Central Bank, the Bank of England and the Bank of Japan – have a combined balance sheet of $10trn after years of stimulus. Debt burdens are high. Wage growth is anaemic at best. The concomitant social tensions are evident, and geopolitical tensions are making an unwelcome return to the global stage after the extended entente cordiale of the past 25 years. The situation gets more complicated. With the exception of the US, the rest are struggling to maintain the facade of growth. Japan’s bold Abenomics experiment has failed to deliver so far and Europe is battling the demons of Greece once again. China’s growth is slowing rapidly as its debt burden becomes destabilising, while growth in the other BRICS (Brazil, Russia, India and South Africa) is turning out to be mostly half-baked. Even where quantitative easing has had some success, chiefly in the US and UK, real wages have been stagnant. These are not the foundations policymakers hoped for when planning for recovery. Inflation is conspicuously absent and, with it, any realistic prospect of deleveraging in real terms. Even in the US, where growth has been sustained in recent quarters, the Federal Reserve has made it clear it is focused on unemployment reduction and wage growth as key determinants of genuine success. So far, there is little evidence these policies are delivering sustained results. Throw falling oil prices into this disinflationary environment and you ratchet up the stress factor for policymakers. Already, the rapid fall in oil prices has caused inflation to significantly undershoot expectations. Europe tipped into outright deflation in December, while the UK CPI fell to 0% in February – the lowest since records began. Meanwhile, the wider risks to growth mount. Against the stimulus of lower oil prices, the International Monetary Fund cited lower investment, market volatility, stagnation in Europe and Japan, and geopolitical events as risks that forced them to revise global growth lower by 0.3 per cent. Alongside, much as ‘good’ deflation from China in recent decades stretched pay packets further (even as they shrank in real terms), falling oil prices have enhanced disposable income and dampened the conventional dynamics that push wages higher. Annual wage growth is likely to continue to disappoint, heaping further pressure on policymakers, although the latest UK data has given the first glimmer of hope on this front. The natural reaction for policymakers is to postpone any tightening and reach for further monetary stimulus in an effort to stoke inflation and demand. The amount is simply proportional to their fear of deflation. Quantitative easing, once unconventional, is now conventional warfare for those at the zero interest rate bound. Japan has renewed its vows of marriage to Abenomics. The European Central Bank may have come late to the QE party, but Mario Draghi has unveiled an ambitious €1.1trn programme of bond-buying that original thinkers have christened ‘Draghinomics’. Even the US is under more pressure now to leave interest rates lower for longer and maintain an accommodative stance, thanks to the strengthening US dollar. Under these circumstances alone, the balance sheet of the ‘big four’ will grow by some 25% to nearly $13trn by the end of 2017. This is a huge amount of monetary stimulus on top of the $500bn of ‘fiscal’ stimulus already provided by falling oil prices. The real danger, perhaps even likelihood, is one of hyper-stimulus. The quantum of stimulus already to date, alongside its distortion of the yield curve, have proved powerful steroids to financial markets. Add in more, and you suppress yields even more. As an example, the pool of European bonds with negative yields has increased a hundred-fold from $20bn to more than $2trn in just a year. This reinforces both the vicious crush for yield that has driven investors, particularly those with liabilities, into every asset class that promises a ghost of a return, and the moral hazard of the policymaker put option.