The End of Monetary Policy Ushers in a Messy New Age
Central banks have ruled the roost. Investors might find that frustrating, but what comes next?
By Richard Barley
Markets are increasingly questioning the ability of central bankers to address the problems facing advanced economies. Investors should also consider that a world where monetary policy is less central may be even more uncomfortable.
Central banks have held sway in markets. The introduction of quantitative easing in the U.S. halted the collapse of late 2008 and early 2009. Further rounds of QE and its widespread adoption, including by the European Central Bank, have powered markets onward, taking bond prices to dizzying heights.
Markets are central to the implementation of monetary policy. Influencing asset prices is at the heart of the attempt to shift financing conditions to improve prospects for the real economy.
Central bankers need to keep markets onside.
Yet asset-price inflation hasn't delivered a powerful economic recovery.
The persistent problems that many countries have faced since the global financial crisis are causing shifts in politics away from the established orthodoxy. From Donald Trump in the U.S. to the 5 Star Movement in Italy, politics is getting more volatile.
The U.K. is a clear example. The Brexit vote was a rejection of the status quo that has caused politics to become the primary consideration for investors. Look at the value of sterling, which until this year was driven largely by expectations of changes in U.K. monetary policy relative to policy elsewhere.
The regime shift has been seismic, in part because the U.K. was previously a highly conventional, market-friendly economy.
Even less dramatic shifts than Brexit, such as the much-discussed move to make greater use of fiscal policy, will change the terms of engagement for investors. Financial markets may no longer be “front and center,” asset allocation strategists at HSBC think. They will be more the reflection of policy rather than the target of it. That may sound like a subtle distinction, but it is a potentially important one.
A world centered on central banks offers a great deal of opportunity for careful communication tailored to investors. The flow of information is organized, with calendars of meetings, news conferences and speeches, reams of research and publications. Investors can obsess over tiny shifts, for instance in the Federal Reserve’s so-called dot plot. Monetary policy tends to work incrementally and involve a great deal of signaling.
Politics can be far messier. Markets will be keenly interested in fiscal policy, but may also have to cope with accompanying shifts on trade, immigration and industrial policies. Decisions may be less timely, and market expectations and responses less important, unless they are extreme.
Central banks have fixed mandates, but the political script can be rewritten rapidly.
The shift away from the established economic and political order increases the risk of outcomes for which markets aren’t prepared. Investors might feel frustrated at the way that central banks have come to dominate markets. But politics may make predictable returns harder to come by.