If there has been one thing markets have become accustomed to in the years following the global financial crisis, it’s the expectation that central banks will collectively do “whatever it takes” to prevent pockets of volatility from becoming a fully-entrenched, large-scale financial crisis.
Ultra-easy monetary policy was delivered like clockwork by the likes of the Federal Reserve, European Central Bank and Bank of Japan, among others, whenever market ructions were threatening to disturb the fragile global economic recovery.
While there is little doubt, at least when it comes to asset prices, that their policies have worked, with most major central banks now at or nearing the limits of what monetary policy can deliver, there are now increasing doubts that additional policy easing will be able to address the recent slide in risk assets.
One only has to look at the recent performance of asset prices in Europe and Japan – two regions that have seen the monetary taps loosened even further in recent months – to see the diminishing impact that the likes of quantitative easing, and in the case with the European Central Bank negative interest rates, is delivering.
Michala Marcussen, global head of economics at Societe Generale, is one prominent analyst who believes that additional monetary policy no longer carries the same punch as it once did before, suggesting that other factors besides central bank policy will need to align in order to address the recent bout of risk aversion.
In a note released over the weekend, Marcussen looks at the factors she believes will need to occur in order to settle financial markets in the period ahead.
Unsurprisingly, stabilisation in the crude oil price and Chinese yuan – two factors that have rattled financial markets since the beginning of the year – are at the top of her list.
Here’s a snippet from her report on why energy prices need to stabilise.
As short term circuit breakers of the vicious circles, oil itself somewhat ironically offers one of the greater hopes. At some point, prices will stabilise and ultimately calm broader financial market fears. In turn, this should help support consumer confidence, and notably in the advanced economies allowing them to spend what is a very significant oil dividend.
And here’s why she believes a reversal in Chinese financial market reforms may actually help to underpin a recovery in confidence, at least in the short term.
When it comes to other short-term circuit breakers, an additional strengthening of Chinese capital controls would ease some of the near-term concerns albeit against the objectives of longer-term reform. Also helpful, would be some on budget fiscal easing which we expect to be announced at the National People’s Congress in early March. Indeed, it will be interesting to see what advice the IMF offers when they release their new outlook on Tuesday.
Marcussen also suggests that a better, if-not-great, Q4 earnings season for US firms, along with supportive technicals, may also help to underpin fragile investor confidence.
Should those four factors fail to materialise, Marcussen suggests that it’ll be left to governments, not central banks, to break the vicious cycle of concerns around slowing economic growth leading to financial market losses.
“While central banks may help, we are today less confident in central banks’ abilities to be a real game changer, at least not without the addition of fiscal stimulus which at least for now seems unlikely to come on a large scale,” says Marcussen.
“As we have discussed on previous occasions, we believe that a further significant deterioration in the economic situation would ultimately trigger a more aggressive fiscal response from the world’s major economies. The risk of global recession, however, remains high at 10%.”