Saturday, September 23, 2017

Is the end of QE in sight?

Insurers hoping for a return to higher interest rates and better investment returns were disappointed by testimony from the chair of the US Federal Reserve this week.

Janet Yellen’s remarks to Congress were widely interpreted in both the media and among analysts as being relatively dovish on the future path of US interest rate policy. “Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance,” she said.

Indeed, with inflation stubbornly below the Fed’s target of 2% and the fairly modest wage growth experienced by US workers in recent years, it would appear that further interest rate hikes are at least questionable. Indeed, the core consumer price index for the 12 months to the end of May was just 1.7%.

“For a US economy that is widely presumed to be nearing the hallowed ground of full employment, this comes as a rude awakening,” worries Stephen Roach, the former chairman of Morgan Stanley Asia and the firm’s chief economist.

Rabobank’s Jane Foley suggested that Yellen is “wobbling” over her commitment to unwinding quantitative easing (or, in the language of central bankers, pursuing a gradual path toward rate normalisation and a shrinking of its balance sheet).

Not everyone agrees, of course. Rick Rieder, BlackRock’s chief investment officer of global fixed income, argues that much of the commentary on Yellen’s remarks has been short-sighted. He sees nothing new in the language she used and claims that she has been saying much the same thing since at least March.

“While many appear to perceive a significantly dovish tilt to yesterday’s comments, we would suggest that they remained roughly in line with information we already have gleaned,” said Rieder in a note to clients on Thursday. “The Fed is committed to continuing to normalise rate policy this year and to initiating balance sheet reduction, and we believe it is targeting three rate hikes for 2018.”

Economists are often inclined to find reasons for why the normal laws of economics no longer apply, and for Reider the persistence of low inflation and weak wage growth are no reason to hold back the unwinding of QE. Instead, they are a result of trends such as “just-in-time hiring, technology-driven job efficiencies, a lower goods-producing (high-wage) workforce and a rapid growth of temporary hiring (which is to say, more permanently temporary employees)”.

In this context, far too much weight is laid on the 2% inflation target, he argues. If he is right, investors can look forward to the Fed starting to shrink its balance sheet in September and a further rate hike in December.

However, the flip side of this is that the Fed’s actions might not matter much if the unwinding of QE isn’t coordinated with central banks in Europe and, in particular, Japan. The BoJ remains in the easing mode initiated under prime minister Shinzo Abe’s plan for economic revival and insurers hoping for an end to miserly returns may be disappointed.

“The hunt for yield and returns is a global endeavour and excessive focus on policy in one region can result in misapprehending the total picture,” warns Rieder. “So, while Fed policy is likely to very deliberately promote higher real rates, as to some degree ECB policy will too, we think BoJ policy will remain highly accommodative for a while still.”

Even so, the point may be nearing where even the BoJ starts to retreat from QE, setting yields on a higher course globally. That will undoubtedly be welcome news to insurance asset managers—assuming that economists such as Rieder are right about the inflation target.

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