Five years beyond the financial and economic crisis, weariness with hyperbole and economic shock-talk should come as no surprise. But it stands that the world has experienced a long list of unprecedented occurrences that have caused turbulence, uncertainty and, as a result, a fuzzy picture of the near-term future. One of these is quantitative easing (QE), a never-before-used retrospective remedy for the Great Depression that gained currency in the 2008-09 cash crunch. With global growth returning, there is a lot of debate about unwinding QE. Should we worry?
QE is nothing if not dramatic. Unleashed on the U.S. economy in three waves, it ended up injecting a $2 trillion mountain of cash on top of a monetary base that was less than $1 trillion in 2008. The latest phase involves injecting an additional $85 billion into the economy monthly. It is hard to do justice to the magnitude of these moves with mere words. It is equally hard to gauge the impact of these moves on real economic growth. Academics will likely be analyzing this program for decades to come. But most people can’t wait that long; can we assess its market impacts with what we currently know?
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What seems obvious is that certain key asset prices moved significantly with the onset of the first wave of QE. Subsequent rounds appear to have had additional, although more muted, effects. Between early 2009 and late 2012, key increases were obvious in stock markets, currencies and key commodities, and at the same time there was an obvious compression in bond markets—with a noticeable bias toward high-yielding, emerging market paper.
At the very mention last May that the Fed was considering tapering its current round of monthly bond purchases, markets went into an immediate tailspin. Each of these asset classes reversed movements seen in the previous four years, as traders sought to price in the expected effects of the unwind. The turbulence exacerbated slowdown that was already underway with the uncertainty of tightening liquidity, compounded by a depreciation in currencies.
Since then, expectations of imminent tapering have faded. Initially expecting a gradual reduction of the Fed’s monthly purchases to commence in September, markets now believe that changes won’t come until next April at the earliest. At this point the extent to which markets have priced in these moves is unclear. Key to their current actions is the collective expectation of the timing, the duration and extent of the unwind. At the same time, market moves are likely being tempered by the fact that tapering will only occur if preceded by a convincing increase in growth and easing elsewhere.
Whatever the net effects, emerging markets are likely to experience both volatility and some tightening of liquidity. The effects will not be even, though. Countries that experienced a greater influx of “hot money,” more rapid extension of domestic bank credit and wide current account deficits will likely be more affected as monetary policy tightens. On the top of the list are Turkey, Sri Lanka and India. Three of the major emerging markets are in the top 10.
Clearly, the return to global growth will bring challenges. Liquidity will tighten as growth ramps up, but in a way that has never really been experienced before. It is likley to be an interesting ride, and one that favours those that have access to a steady source of liquidity.
The bottom line? As quantitative tightening sets in, get ready for a new acronym—and yet another journey through uncharted economic waters.
Peter G. Hall is vice-president and chief economist at Export Development Canada