The world championship in accommodative monetary policy is fully under way, with most of the world participating. At least that’s how it seems when you look around at the world’s central banks.
Whereas investors feared rising interest rates a year ago, that picture has completely reversed. Both the US and EU central banks are on track to cut rates later this year, while according to a report from investment bank Bank of America Merrill Lynch, some 37 emerging market nations have an accommodative monetary policy in word or deed – including China.
Here, Danske Bank’s investment strategist, Lars Skovgaard Andersen, gives his assessment of the trend and its significance for investors:
Why are all central banks suddenly focused on monetary policy easing rather than tightening?
The easing focus is due to the recent slowdown in economic growth and the low level of inflation across much of the world, plus the risk that Donald Trump’s trade war will reinforce uncertainty and weaken the global economy further. These factors have caused central banks to reassess their monetary policies. Their easing actions are not being driven by the prospect of an imminent recession, but rather a desire to stimulate growth and inflation and also to prevent their economies from slipping into recession anytime soon.
Think of monetary policy easing as a type of insurance. The more the economies of the US and Europe slow, the greater the risk that new, negative events – such as a further escalation in the trade war – could trigger a more pronounced economic downturn. Central banks are easing in an attempt to reduce this risk.
What specific measures do you expect from the central banks during the rest of 2019?
We are particularly focused on monetary policy in the US and Europe, and currently expect three interest rate cuts from the US central bank (the Fed) before the end of the year plus one rate cut from the European Central Bank (ECB). We also expect the ECB to restart its bond buyback programme (QE) in order to push rates and yields down and supply the markets with liquidity.
Is it normal to see central banks moving in synchrony?
Yes, this is often the case. First of all because economies are linked, so a growth slowdown in the US, for example, will also have a negative impact on other economies. And secondly, rate cuts in other countries can prompt a central bank to follow suit – for if one country suddenly has a tighter monetary policy than other countries, this will typically strengthen that country’s currency, reducing its competitiveness and hitting exports and hence its economic growth negatively.
What significance does an accommodative monetary policy have for investors?
We are now in the late phase of the global economic upswing, and our assessment is that monetary policy easing by the central banks can reduce investor uncertainty and extend the upswing – and thus also extend the period of rising equity prices. The new, more dovish, tone from the central banks also supports our expectation that equities will generate a reasonable return over the coming year. We are therefore maintaining the moderate overweight in equities in our portfolios and our corresponding underweight in bonds.
Are there certain equities that particularly benefit from an accommodative monetary policy?
Most companies benefit from low interest rates, but they can be particularly beneficial for dividend-paying stocks – in other words equities in companies that regularly pay out decent dividends to shareholders. Bonds have become less attractive over the past half-year for investors focused on investments that generate a regular income, and this makes dividend-paying stocks a relatively more attractive alternative. The more dovish tone from central banks is therefore also one reason why we currently see the most attractive return potential in dividend stocks.
IN BRIEF: What is an accommodative monetary policy?
When central banks pursue a loose or accommodative monetary policy they stimulate economic growth by making it easier or cheaper for consumers and businesses to borrow money – for example, by cutting interest rates or in some other way easing credit conditions. Since the financial crisis, central banks have also made very substantial purchases of bonds in order to push yields and rates lower and send more liquidity out into the economy – in other words, increase the volume of money in society.
Når centralbankerne fører en lempelig pengepolitik, stimulerer de den økonomiske vækst i samfundet ved at gøre det nemmere eller billigere for forbrugere og virksomheder at låne penge. Fx ved at sænke renten eller på anden vis lempe vilkårene for udlån. Siden finanskrisen har centralbankerne også foretaget store opkøb af obligationer for at presse renterne ned og sende mere likviditet ud i økonomien – dvs. øge pengemængden i samfundet.
Disclaimer: Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss.