An article in FT.com “Bond bubble brews as central banks retreat from QEtoday expressed worry that global central banks will end Quantitative Easing thus triggering a rise in rates. I disagree. Ultimately central banks will act to avoid triggering a crisis and will let any tapering plans be controlled by a need to taper gradually so as to avoid a crisis. What is more powerful than central banks and their ownership of bonds is the marketplace. By “marketplace” I mean the global market for all types of goods and services. I expect global GDP to continue to have a weak growth rate with minimal chances of it suddenly improving. Unemployment will also have minimal chances of suddenly improving, when adjusted for quality jobs. The two drivers of interest rates are GDP growth and employment growth. These two are weak and have no known source of increasing their rate of growth. Thus it is unlikely that inflation will explode upwards and thus it is unlikely that central banks will engage in reckless tapering of QE programs that would raise rates.
The EU has a very high and intractable level of youth unemployment. China is the main source of the world’s growth but that economy is credit bubble which can’t expand forever, at some point it will have to default on debt and stop growing, much as Japan’s 1980’s bubble finally ended in 1990. Trump was allegedly going to make the U.S. economy grow and increase domestic employment with trade barriers. But nothing has happened in Washington this year.
The EM countries have enormous and growing capacity to make high quality, low cost goods and services. This puts downward pressure on prices and reduces employment for Developed countries, which thus keeps global inflation and interest rates low.
The world has changed drastically since the 1994 surprise Fed tightening that doubled rates from 3% to 6% in a few months. Since then the world has added enormous manufacturing capacity, especially in China, and enormous debt, both of which can be deflationary or disinflationary. Servicing excess debt acts like a tax which dampens the ability to consume and is thus deflationary. Also since 1994 the internet has grown thus enabling the disinflationary impact of companies like Amazon.
The central bank’s inability to fix the economy since the 2008 crisis using low rates and QE has damaged their credibility thus reducing their powers to reflate the economy out of the next recession. Thus it is unlikely that a sudden surprise increase in growth or inflation will occur. Instead the surprise could be a recession where central bank activities fail to provide relief thus forcing Congress to use fiscal stimulus just when the debt load is too high. Thus the economy could be heading into a less than positive outcome where the new QE tools of Fed easing and traditional Congressional fiscal stimulus either don’t work or can’t be implemented because the federal debt load is too big.
This would be deflationary. The market tries to anticipate the future path of the economy. As more investors become aware of these risks they may decide to reallocate their portfolio to prepare for the next recession and thus begin buying bonds and selling stocks, which means the future is the opposite of what the FT article suggests.
Investors need independent financial advice about the risks of being surprised by recession and disinflation instead of being surprised by rising interest rates.