For the first time in several months the equity market outlook looks quite uncertain. Until now, investors had not needed to worry about an end to the massive stimulus programme being conducted by the Federal Reserve. As May gives way to June, however, dark clouds loom.
Does healthy growth mean an end to QE
Quantitative easing (QE), as originally practised in the aftermath of the financial crisis, was an emergency measure, a stop-gap to prevent a complete financial collapse. However, as time has gone on, it has become a useful tool to stimulate the economic recovery in western economies. The latest version, dubbed QE3, sees the Fed purchasing $85 billion a month in mortgage securities. This has helped ignite the latest phase of the equity rally.
It seems the Fed’s efforts are paying off. US economic data, such as GDP, non-farm payrolls and (crucially) housing sales, is picking up. The programme, it appears, works. Yet markets have become very comfortable with active central banks. Capitalism red in tooth and claw it is not, but the ‘liquidity punchbowl’ has nonetheless allowed stock markets to race to new all-time highs.
Now that the US economy is on the mend, it is perhaps time to at least start thinking about how to wind down this stimulus without creating market gyrations. This is something that has already begun, with articles in the Wall Street Journal about a ‘tapering’ of asset purchases, while this week’s Fed minutes showed that some members want to start reducing QE3 quite soon.
Markets have not liked this. It has disrupted the latest surge in the equity rally that began back in autumn last year. Combined with a weaker Chinese manufacturing number it was enough to cause the Nikkei to drop 7%, although the reaction in the US was more muted.
As we look to the month ahead, some of this talk will die down. Each new piece of US economic data will be analysed to see whether it supports the idea that the Fed will cut back on stimulus sometime this year. This, far more than the eurozone crisis or the reflationary policies being enacted in Japan, will be the event that determines whether the summer of 2013 will yet turn out to be another weak period for equity markets.