In the space of eight weeks, 15 central banks have either cut rates or have changed their policy statements to dovish or have stated a cut is coming. The heat from central bank policy is reaching fever pitch.
Having a look at the bond markets, they clearly illustrate that the current easing cycle is far from over. Ten-year German bunds fell below Japanese government ten-years (JGBs) for the first time in history.
The reason for this switch is expectations are building that the €60 billion a month QE program from the European Central Bank may have to expand further still to ward off deflation. Conversely, Japan is also failing in its mantra to increase inflation. Its current program may also have to expand further despite already being one of the most aggressive on the planet. There is a race to the bottom here.
Moving to those nations that have cut interest rates on concerns around disinflation (in some cases deflation), ‘below trend growth’ (globally and domestically) and ailing demand - all are also facing similar expectations to QE programs. Further cuts are coming.
The question you need to ask from this is: What if the current programs don’t stave off deflationary pressures? What if growth continues to contract, bulk savings continue and consumption doesn’t return to trend?
Reining in inflation is a relatively simple monetary process as increases to interest rates is a blanket depressor and the effects filter through relatively quickly. The issue the globe is facing around deflation is that it’s so hard to break out of – it becomes a perpetual issue as prices can be cheaper next week, month or year. This kind of setting also breeds the biggest problem in this kind of global environment - risk aversion.
Savers continue to store capital even with the negative rates from the likes of the ECB and the Swiss National Bank, or record low rates from other central banks. The ability to force funds out in the market is tough. However, when it does flow it has an interesting effect on wealth.
The funds continue to find themselves moving to equity markets rather than anything else (ie. business development or funding of growth projects). The clearest example of fund flows to the markets is the DAX. Record highs are currently being printed daily and investment in the German index is not slowing. The stimulus from ECB’s Frankfurt headquarters is just moving across town to the Frankfurt exchange.
The markets will no doubt champion what is currently being forced on them by monetary policy as funds will flow into equity coffers. It is why the baseline starting point in my equity strategy is industrials with yield - money markets and bond markets have become so crowded and overvalued that the way to gain total returns in the current global marketplace is via equities. However, when this trade is fully valued and inflation still can’t be found – what then?
Ahead of the Australian open
The RBA is now part of this global central bank trend. The reactions in the ASX yesterday showed it too will benefit from the current setting, moving to six-year highs following the rate cut.
The fact economists and the swaps markets alike are also expecting a further 25-basis-point cut in March or April will only enhance this trade in the coming weeks. We are currently calling the ASX up 82 points to 5789, a level not seen since May 2008.
Today will be the tenth consecutive positive trading day and would mean the ASX is up 378 points, or 6.9%, in 2015. The fact oil continued to rally overnight and Greece stepped back from its treat to break its current commitments with the European Union will only added to the upside moves in equities. The green on screen today is likely to be universal and energy and the banks will likely be the strongest movers.