Rensburg Sheppards' Investment Management Simon Kaye looks for a thaw in financial markets
Dec 14 2010 by Henryk Zientek, Huddersfield Daily Examiner
AS winter has set in for much of northern Europe, hopes have been building that a thaw in financial markets is around the corner.
The delivery of an extended programme of quantitative easing – QE2 – in America appears to have been successful in reassuring risk-takers there that a safety net is in place, persuading them to ignore the unsettling creaking sounds emanating from the becalmed and plainly listing ship that is the Eurozone.
Many of those who follow monetary policy closely have questioned whether QE2 measures are necessary, arguing that liquidity is plentiful and that it is the demand for credit not the supply that is the problem.
Some even go further and suggest that this massive experiment in monetary policy risks a series of unintended consequences, including an upsurge in inflation and possibly a fracturing in the complex web of international trade agreements that rely for their existence upon relatively stable exchange rates between major currency blocks.
In short, the real fear, to return to a nautical analogy, is that we are in uncharted waters – we have no idea whether the dramatic policy measures currently being implemented will work at all, or whether they may work too well.
Undoubtedly, there will be unintended consequences from the remedial fiscal and monetary policies implemented in the West.
However, the real question is whether these costs will be greater than the costs of a failure to re-ignite self sustaining growth in the developed world.
Looking at the first concern, that of a rise in inflation, to the extent that an avoidance of deflation is the goal of many of these policies, we hope that some greater inflationary pressure does become apparent.
However, the real concern is that this could be uncontrolled. This is unlikely, in our minds, unless the loose monetary conditions are not withdrawn quickly enough once they have begun to take effect.
The key is to understand that the enormous sums of money being supplied to the financial system through many conduits (US Troubled Assets Relief Programme, European Financial Stability Facility, US QE2 etc) either replace existing facilities – themselves put in place to replace the evaporation of the “shadow banking system” – or else, they are far from “cost-free” loans.
In essence, they amount to a kind of “confidence trick” – where the trick is to keep the markets from freezing in fear of a repeat of the conditions of 2008 for long enough to allow the animal spirits of businesses, fuelled by high current levels of profitability, to reassert themselves. In short, they are programmes of sustenance whose goal is to provide a bridge to sustainability.
This is where we return to the Eurozone. While it is clear that the US and the UK have embraced the concept that doing too much is a risk worth taking – the structure of decision-making in Europe makes it less clear that the same conclusion has been reached.
Until this is the case, financial markets will continue to test the European Central Bank’s resolve, suspecting a disorderly break up to the Euro could be possible. This is one of the so called “tail risks” whose nature makes it difficult to wholeheartedly embrace equities, since the price of such a failure would almost certainly be a recession.
We expect Europe to step-up its emergency support measures very soon, however reluctantly.
