After three rounds of quantitative easing (QE) in the US and monetary easing in Europe, the UK and Japan, and the resulting rush of global liquidity, what has been the reaction of the markets? It has been widely believed that the monetary easing programmes would lower bond yields, thus meeting a two-fold objective of allowing beleaguered banks to recapitalize themselves by borrowing at the short-end and investing in long-dated bonds and that, because of the low bond yields, investors would put their money in risk assets such as stocks and commodities. US Federal Reserve chairman Ben Bernanke’s great plan to revive the economy apparently hinges on the wealth effect created by a rising stock market to stimulate the US economy. Did it work out the way it was planned?
In the US, the stock markets did, indeed, react the way they were intended to. By September, the MSCI US index had steadily climbed to a level that had not been seen since December 2007—the year the financial crisis started. Sure, the US market has lost some ground recently because of fears about spending cuts and tax increases that make up the so-called fiscal cliff. But there’s little doubt equities in the US have moved up on the back of quantitative easing. To what extent that has translated into improving the US economy, however, is doubtful.
Interestingly though, monetary easing hasn’t had the same effect on the equity markets in the UK. The MSCI UK index, before the recent sell-off, was lower in September than in December 2010. It has more closely followed the MSCI Europe index, which, too, is below the level it was in December 2010. Clearly, the structural problems within the euro zone are holding back the stock markets there, despite the ultra-loose monetary policy.
In the emerging markets, it does seem as if the last round of quantitative easing has had no effect at all. The MSCI Emerging Markets Index is at around 970, well below the level of 1,202 it reached in April 2011, when the second round of quantitative easing (QE2) ran out of steam. Both MSCI China and India are well below the levels they were at in October 2010, a few months after the second round of quantitative easing by the US Fed had started. MSCI India, currently at 719, was at 839 in early November 2010. MSCI China, currently at 58, was at 70 on 2 November 2010.
Another widely predicted consequence of the waves of quantitative easing was that commodity prices would go through the roof. The argument was that with financialization, commodities had become just another asset class to be traded, and liquidity would buoy commodities as well. The problem is that the Thomson Reuters/Jefferies CRB Index is way below the level it was at in April 2011 and is more or less where it was in August 2010, just before QE2 started. Commodities haven’t really reacted as predicted.
What can we conclude from this overview of the markets after QE3? There’s little doubt that the yields on the US treasuries have fallen drastically, which was the objective of the central bank’s QE programme. That has, in turn, led to investors moving to US equities. As a note by the Bank for International Settlements says, “Such portfolio rebalancing is one of the key objectives of unconventional policies, intended to stimulate investor risk-taking by reducing the attractiveness of government securities relative to risky assets.”
Elsewhere, however, the spillover into equity markets from the US quantitative easing programmes didn’t have the same effects, nor have the monetary easing programmes in the UK and Europe been that effective. Clearly, the impact of higher liquidity has been tempered to a great extent by the poor fundamentals of the economy in Europe and the uncertainty about the future of the euro zone. But then, it’s also likely that markets would have been even lower but for loose monetary policy.
In India, too, the liquidity effect of the US monetary policy has had to contend with the tight money policy of the Reserve Bank of India. The Chinese central bank, too, has tightened policy to combat a real estate bubble. Further, in view of the strong correlation between Chinese growth and commodity, especially metal, prices slowing, Chinese growth has probably more than offset the effect of loose US and European monetary policies on commodities. The dollar index has displayed no particular trend, see-sawing over the years. Even the price of gold hasn’t touched the heights reached in September last year.
To be sure, markets move up when quantitative easing is announced, but their effect seems to be getting progressively lower. It’s tempting to compare it with the effect of a drug, whose impact wears out from over-use. Japan, of course, would be the classic example.
Manas Chakravarty looks at trends and issues in the financial markets. Comment at firstname.lastname@example.org