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Global markets reacted sharply to the key economic data from China, amid hints of the winding down of the quantitative easing (QE) programme of the US Federal Reserve. Jan Lambregts, managing director and global head of financial markets research, Rabobank International, tells Puneet Wadhwa the Fed will slow its purchases in the first quarter. As regards Japan, while a boost in public spending under Prime Minister Abe could see a jump in gross domestic product, the longevity of these policies is very much in question, he adds. Edited excerpts:
What is your interpretation of the key US economic data and recent statements by the US Federal Reserve? How stable and dependable is the macro-economic recovery in your opinion?
The recovery is still only a very moderate one, which shouldn't be surprising, given that we have seen an economic recession team up with a financial crisis in the past years. Historically, the coincidence of both typically is followed by more muted recoveries. We continue to see only a moderate global growth picture in the upcoming years.
It is clear that the tapering off QE3 has become a dominant market driver. While Bernanke's apparently hawkish remark might have been an innocent attempt to illustrate the flexibility of the Fed's asset purchase program, it did confirm the market's suspicion that the FOMC (Federal Open market Committee) is at least talking about tapering off QE3 in the next few months, and for some in the market it is even a signal that we could see the Fed tapering off QE3 in the near future.
Since fiscal policy uncertainty is likely to restrain the recovery at least until September, we do not expect a meaningful acceleration in the US labour market before Q4. Therefore, our guess is that the Fed will slow down asset purchases in Q12014, before terminating QE3 altogether later in 2014.
Do you think central banks across the globe will gradually wind down the quantitative easing/stimulus programmes over the next couple of years? What is the likely impact of this on the global markets?
Against only a moderate global growth environment, we think many of the central banks still find it difficult to reverse the extraordinary monetary stimulus they embarked on during the height of the financial crisis. Many of these banks have lost a considerable amount of their de-facto independence, as politicians have in part successfully blamed central banks and regulatory oversight for part of the crisis.
Next to that central bankers are always popular when they open the cookie jar, but not when they close it. So, they are likely to elect to be behind the curve of any economic recovery. That's near-term a positive for nearly all asset markets, as the rising tide of liquidity lifts all boats. But longer-term, it raises the spectre of inflation and a serious misallocation of scarce resources.
What is your reaction to the development across Japan? Was the reaction of the equity and the bond markets overdone? What is the road ahead for the Japanese economy?
As mentioned in a recent report, we think that the Japanese economy is performing better as sentiment across the economy has risen in reaction to the government's and BoJ's (Bank of Japan) 'whatever it makes' ethos of the past few months. Confidence has improved across the economy with, for example, the Economy-Watchers survey rising in March for the fifth straight month.
The BoJ has announced an aggressive easing and will ramp up its purchasing of government bonds (JGBs) to keep interest rates lower across the yield curve. This will provide some monetary boost to the economy. We note that a boost of public spending under Prime Minister Shinzo Abe could see a jump in Q213 GDP, but the longevity of these policies is very much in question.
What is your assessment of how things are stacking up in the Euro-zone? Has there been any significant shift towards the positive over the last one year?
Important progress has been made. Middle of last year the Van Rompuy plan towards a closer Union for the first time saw both the core and peripheral countries agree on the destination for the road ahead. When ECB President Draghi weighed in, proclaiming the central bank would do "whatever it takes", market sentiment took a decisive turn for the better.
Structural reform progress remains a slow and painful process, but it's underway and delivering some early results. However, nothing ever goes easy in the Euro zone and you very much need the pressure of the crisis to keep the pace of good developments going.
How would you allocate resources now given that we have already seen a rally in the risk-on asset class? Would you use this opportunity to add on to your risk or equity positions?
The liquidity tide is very much raising all boats. It's unwise to fight it at this time. We expect the spread between core and peripheral bonds in the Euro zone to narrow further, while equity markets should be able to sustain or even build on recent gains. As such, the mood very much remains risk-on. We'd caution though that fundamentally a lot of work remains to be done. What we are seeing is the triumph of liquidity over fundamentals.
What is the outlook for key currencies?
At the start of this year, strong US economic data was very supportive of the consensus view that the USD would have a good year. However, US retail sales data and many of the forward looking April surveys have also disappointed. The recent deterioration in economic data suggests there may be too much good news priced into the USD.
We think the aggressive policy action that was announced by the BoJ in early April does suggest that the JPY should weaken over the medium term. The BoJ has pledged to double its government bond holdings in two years implying a significant increase in yen liquidity.
As regards GBP, going forward, the weak UK economy and the risk that the BoE could ease later in the year should ensure that sterling's upside is limited. We see risk of a push back towards the 0.88 area by the end of the year.
