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On Wednesday, the Federal Reserve set the direction for US monetary policy. As far as the Fed is concerned, the only way is up.
Yesterday, it was the European Central Bank’s turn.
As usual, the eurozone’s central bank boss, Mario Draghi, managed to keep everyone happy. He’s ending quantitative easing – but incredibly slowly.
So what does that suggest for your portfolio?
The toughest job in central banking
As I have said many times before now, Mario Draghi, head of the European Central Bank (ECB), has the toughest job in central banking. He has to set a single monetary policy for 19 separate countries, each of which has its own grumpy electorate to keep happy.
To make matters more complicated, the most powerful country in this merry band also happens to be one of the very few nations in the world whose voters actually prefer interest rates to be on the high side.
Take Germany out and replace it with pretty much any other country in the world, and Draghi’s job would be just like every other central banker’s – if in doubt, cut interest rates and print money, and that’ll keep them all quiet.
But no. The eurozone manages to sling together a grab-bag of countries who have mostly put off dealing with their structural problems via periodic currency devaluations, along with virtually the only nation in the world that likes its monetary policy nice and tight.
It takes a special kind of diplomat to pull that off, and that’s just what Draghi’s been doing for nearly a decade now. Yesterday, he did it again.
Markets went into this meeting expecting eurozone quantitative easing (QE) to end. That’s what happened. Draghi managed to keep the hawks happy by putting an end-date on QE.
But he’s done it in a way that will also keep the doves happy. For a start, while eurozone QE will start being phased out at the end of September as expected, it won’t just stop then. The ECB will be buying €30bn a month until the end of September. Then it will drop down to €15bn a month for the last quarter of the year.
So we won’t see the “cold turkey” phase until January 2019.
Even then, it’s not exactly a “hard” withdrawal. Remember that bonds mature – if you buy a ten-year bond when it’s issued, then after ten years, it’ll pay you back its face value.
What do central banks do with that money? Simple – they invest it back into fresh bonds. If they didn’t do that, then they’d actually be tightening monetary policy (by taking money out of circulation).
So the ECB won’t be expanding its balance sheet (ie, doing more QE), but it won’t be shrinking it either.
And then, on top of that, Draghi said that the ECB won’t raise interest rates until late next year at the earliest.
In other words, if you have to end QE at all, then this is probably the most slow and steady way possible to do it.
The world order is changing
Overall, the decision pushed the euro lower (which will please Draghi). And it’ll keep markets calmer than they otherwise would have been.
For example, as Capital Economics points out, the “spread” (the gap) between yields on Italian government bonds and German ones narrowed a bit. (In other words, investors are a bit less worried about Italy going bust than they were).
So it feels a little like “business as usual”. Certainly, stockmarkets were pleased with the tone. Draghi kept his options open too – all of this is “subject to incoming data”. In other words, if things go pear shaped, he reserves the right to start up the printing presses again.
Trouble is, this can’t carry on for long. As I said in yesterday’s Money Morning, a lot of the political contradictions and structural problems across the global economy have been covered over with a flood of liquidity from central banks around the world.
A lot of those problems are still there. Central banks are now reducing the liquidity flood. And as the water recedes, much of the mess that it covered up remains to be dealt with.
That’s why we’re seeing America try to renegotiate the terms of its deal with the world (I’ve written
How to invest as Trump ushers in a new world order
, out today).
The old world order helped to give us the financial crisis of 2008. There’s no guarantee that the new one will be any better, and getting there will be tricky, but the process of change has started.
In Europe, it’s going to be harder. It has to contend with a US that is no longer interested in acting as the global policeman, and it also has to figure out exactly where the European project goes from here.
Just as everyone on this side of the Channel has their own ideas about the exact form that Brexit should take, so there are lots of views on the continent as to exactly what form the future Europe should take.
It’s better to have those discussions now, while the global economy is still in relatively good shape, than to have them when there’s a fresh downturn (as there will be, at some point).
The temptation is to put off these uncomfortable discussions until forced to have them. But that’s rapidly becoming the riskier option. Draghi steps down next year – he’s likely to be replaced by someone who is more hawkish or less competent – or both – than he is (remember Trichet?)
On top of that, the longer these questions remain untackled, the more likely it is that a proper political spanner will be thrown into the works. Populist parties may not be in power in Germany or France, but they have huge levels of support, and that will only grow until voters feel that there is more clarity on what the future holds.
For investors, this could all go either way. But it does suggest that 2017’s almost unnatural lack of volatility is very unlikely to be repeated this year.