Speculation about potential monetary policy changes is rampant throughout the financial publications we follow. One topic that has garnered particular attention: Will monetary policymakers reduce (or taper) the monthly asset purchases made via their quantitative easing (QE) programmes? The Bank of Canada (BoC) started doing so last month, and the Bank of England (BoE) followed suit two weeks ago.[i] Now, many commentators we follow wonder when America’s Federal Reserve (Fed) and European Central Bank (ECB) will taper their QE programmes, presuming this could hinder their economic recoveries. However, we think it is beneficial for investors to tune out the chatter. Our research shows monetary officials’ decisions can’t be forecast, and we have found tapering isn’t negative for economic growth or equities.
In our view, attempts to predict monetary policymakers’ moves aren’t useful for investors. For one, who will be making those monetary policy decisions isn’t set in stone. Take the ECB’s Governing Council, the bank’s main decision-making body, which consists of the Executive Board and governors of the 19 eurozone countries’ central banks. Though the Executive Board’s six members each have a permanent vote, the national governors also have a vote on monetary policy—and their voting rights rotate monthly. Moreover, monetary officials’ posts aren’t permanent. In the UK, the BoE’s Andy Haldane recently announced he was stepping down from his position in June. In the US, speculation is rife amongst financial publications we read over whether President Joe Biden will reappoint current Fed chair Jerome Powell when his term expires next February—if he still wants the job.
Moreover, monetary policy officials—being human—can change their minds. After the ECB reduced asset purchases for the first time in April 2017, we saw financial publications scrutinise then-ECB President Mario Draghi’s words for clues of whether another reduction was forthcoming in the summer. After seemingly telegraphing a soon-to-come taper in June, Draghi walked those comments back a month later—and the ECB didn’t taper again until January 2018.[ii] Officials at the BoE and Fed have also revised their guidance in the past. Former BoE Governor Mark Carney said an unemployment rate of 7% would be the BoE’s interest rate hike threshold in 2013.[iii] By early 2014, with the unemployment rate nearing that stated level, Carney updated his guidance.[iv] Similarly, former Fed Chair Ben Bernanke made a big show of providing numerical criteria for monetary policy decisions in 2012, saying a 6.5% unemployment rate would trigger hike rates, only for his successor, now Treasury Secretary Janet Yellen, to scrap it when she took the reins in 2014.[v]
More importantly for investors, we think divining monetary policymakers’ will is unnecessary—our research indicates tapering QE isn’t a major swing factor for markets. In the month since the BoC reduced weekly asset purchases to C$3 billion from C$4 billion, and the couple weeks the BoE dropped its weekly purchases to £3.4 billion from £4.4 billion, markets have appeared to have taken tapering in stride. Canadian equities are up 3.3% since the BoC’s announcement whilst UK shares are down -1.3% since the BoE decided to taper.[vi] Meanwhile, 10-year Canada and UK government yields haven’t changed much since the news: Canada’s 10-year yield is slightly up from 1.53% to 1.59% whilst the UK’s 10-year yield ticked higher from 0.79% to 0.85%.[vii] Although we wouldn’t read too much into short-term market moves, we don’t think tapering so far has had any discernable effects—a striking counterpoint to the widespread concerns we have seen that tapers are automatically negative.
We think this is useful perspective to have given the warnings we have seen over a potential ECB taper. Some financial commentators we follow argue that, since the eurozone’s recovery is lagging behind the US and UK’s, ECB officials must do all they can to support the economy—especially with the EU’s €750 billion recovery fund still months away from being deployed. But we think recent history disagrees with this viewpoint. The ECB first announced a QE programme in January 2015, even though eurozone gross domestic product had been growing since 2013.[viii] (Gross domestic product, or GDP, is a government-produced measure of economic output.) In December 2016, the ECB announced it would reduce asset purchases by €20 billion starting in April 2017.[ix] Yet that reduction of alleged support didn’t prevent GDP from expanding or eurozone shares from rising 17.0% that year.[x] The ECB’s ending QE in December 2018 didn’t hinder markets or economic growth either, as eurozone GDP grew throughout 2019 whilst eurozone shares rose 18.4%.[xi] Our research shows similar outcomes in the UK and America. We don’t find this surprising, as QE hasn’t worked as monetary policy officials and other experts we follow said it would.
In theory, by reducing long-term interest rates, QE would spur loan growth and, in turn, economic activity. But Fisher Investments’ research shows that QE was ineffective doing so and potentially counterproductive. Banks’ traditional business model is to borrow at short-term rates (e.g., what they pay depositors) to fund longer-term loans. The difference between the two is a proxy for banks’ loan profitability. When monetary policymakers lower long-term rates—whilst pinning short-term rates near zero—it shrinks that gap, which we don’t think increases banks’ propensity to lend. So whilst QE—then and now—has caused money supply to surge, that hasn’t translated into aggressive lending.[xii] Banks’ oceans of excess reserves suggest they have more cash than they know what to do with.[xiii] Money that doesn’t circulate doesn’t do much good (or cause much inflation, for that matter).
Therefore, in our view, ending a programme that doesn’t work as advertised isn’t likely to prove negative for markets.
[i] “Bank of Canada Sees 2022 Rate Hike, Tapers Bond-Buying Program,” Jessy Bains, Yahoo Finance Canada, 21 April 2021 and “Central Bank Taper Timelines Start to Come Into Focus,” Courtenay Brown, Axios, 20 May 2021.
[ii] “ECB Warns Stimulus Programme Still Has a Way to Run,” Staff, BBC, 20 July 2017.
[iii] “Bank Links Interest Rates to Unemployment Target,” Staff, BBC, 7 August 2013.
[iv] “BoE’s Carney Unveils ‘Next Phase’ of Forward Guidance,” Katrina Bishop, CNBC, 12 February 2014.
[v] “Fed Gives Itself a New Target,” Stephanie Flanders, BBC, 13 December 2012 and “Fed Minutes: Committee Agreed 6.5% Threshold Was ‘Outdated,’ Vote to Remove Was Unanimous,” Jeff Cox, CNBC, 9 April 2014.
[vi] Source: FactSet, as of 20/5/2021. MSCI Canada Index return with net dividends, in GBP, 21/4/2021 – 19/5/2021 and MSCI United Kingdom Index return with net dividends, in GBP, 6/5/2021 – 19/5/2021.
[vii] Ibid. Canadian 10-Year Benchmark Bond Yield, 21/4/2021 – 19/5/2021 and UK 10-Year Benchmark Bond Yield, 6/5/2021 – 19/5/2021.
[viii] “ECB Unveils Massive QE Boost for Eurozone,” Staff, BBC, 22 January 2015 and FactSet, as of 20/5/2021. Statement based on eurozone GDP, quarterly change, Q2 2013 – Q4 2014.
[ix] “ECB Extends Bond-Buying Scheme but at Slower Pace,” Staff, BBC, 8 December 2016.
[x] Source: FactSet, as of 20/5/2021. Eurozone GDP, quarter-on-quarter change, Q1 2017 – Q4 2017 and MSCI European Monetary Union Index return with net dividends, in GBP, 31/12/2016 – 31/12/2017.
[xi] Ibid. Eurozone GDP, quarter-on-quarter change, Q1 2019 – Q4 2019 and MSCI European Monetary Union Index return with net dividends, in GBP, 31/12/2018 – 31/12/2019 and “ECB Announces the End of Crisis-Era Stimulus, Switches to Reinvestments,” San Meredith, CNBC, 13 December 2018.
[xii] Source: FactSet, as of 11/5/2021. Statement based on loan growth and M2 money supply growth in the US, eurozone, UK and Japan, year-over-year change, March 2020 – March 2021.
[xiii] Source: European Central Bank, as of 21/5/2021. Statement based on total excess reserves of credit institutions subject to minimum reserve requirements in the euro area, April 2021.
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