Have central banks abandoned the markets?

Have central banks abandoned the markets?



Mohamed El Erian
 
01/11/2018

It was clear at an early stage of the adoption of monetary recovery programs that are now gradually ending that the "nonconventional policies" of central banks were aimed at curbing volatility as a means of promoting economic activity .

It was clear at an early stage of the adoption of monetary recovery programs that are now gradually ending that the "nonconventional policies" of central banks were aimed at curbing volatility as a means of promoting economic activity .

I do not think governments, companies and markets need to be reminded that their business environment is undergoing successive changes, after what they heard from the European Central Bank last week. Despite weak economic momentum and volatile financial markets, the Fed, after the Federal Reserve, confirmed its intention to stop pumping liquidity generously to support economic activity and asset prices .

Certainly, the change in this "global element" translates into fluctuations in market mechanisms, requires a development of investment strategies, and calls for alternatives to growth support policies adopted by individual countries .

The European Central Bank's announcement on October 25 that it is still planning to halt large-scale asset purchases under the quantitative easing program at the end of a year has been recognized by central bankers as a growing list of threats to their economies. At a news conference after a monetary policy meeting, European Central Bank President Mario Draghi said the risks included an unstable trading system, emerging market pressures and tensions between Italy and the EU on the back of the Italian budget .

"The ECB's mandate does not include financing the government deficit," Draghi notes. "The implicit message that governments and markets can not continue to rely on generous and regular injection of liquidity is expected to solve their own problems .

The ECB's signs are in the same context as the Federal Reserve has been for some time. Despite the pressure on the US housing sector, which is the historical prognostic of economic weakness, and despite President Trump's repeated criticisms, senior Fed officials remain determined to continue to raise interest rates while reducing the balance sheet. In addition, the current team in the Council does not resort, like its predecessors, to calm the markets with sweet words .

The volatility of the markets does not seem surprising and should not be surprising. It was clear at an early stage of the adoption of monetary recovery programs that are now gradually ending that the "nonconventional policies" of central banks were aimed at curbing volatility as a means of promoting economic activity. Central bank positions have also been firm in revealing their intention to abandon those programs as required by economic conditions .

The journey resulting from the implementation of non-traditional policies for a long time involved more financial and economic volatility. This was clearly consistent with market forces' estimates of the volume of liquidity risk in certain sectors and how many governments are slowing down the implementation of structural reforms supporting growth. But the end result remains questionable and depends mainly on the organization and comprehensiveness of the process of transition to reliance on the basic components, both economic and trade, in addition to the restructuring of the mechanisms of the markets .

I reiterate here that the transformation has become more ambiguous due to the differential performance of the developed world economies, as well as uncertainty about trade policy .

This transformation will be tested under two factors :

First, the size of the excessive investment in risk during the previous period of excessive liquidity (whether to achieve exceptional returns through exposure to risks outside normal investment or because of the proliferation of investment vessels that are easy to liquidate for reasonable profits regardless of the nature of assets ).

The second factor relates to the extent to which some governments and companies exploit the low interest rate opportunity to accumulate a lot of debt and allow the chaos of currency trading. The message central banks are focusing on today is their insistence on giving up curbing market volatility, and that will happen overnight .

Hence, economic and market forces are required to prepare for more surprises in the work environment, stemming from the attempt to abandon exceptional and experimentally based standards to historically credible standards as a result of market mechanisms .

This change is qualified to place both the global economy and markets on firmer, longer-term bases. But it also requires timely adjustments in markets and economic policies, otherwise wait for the next worst .

* Senior Consultant at Allianz Group

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