Central banks are creating zombie investors

Almost ten years of central bank quantitative easing schemes and falling interest rates have distorted asset prices, but perhaps, more importantly, it has changed investor behaviour. The lessons from the Great Recession and the ramifications for people on the less fortunate end of the socioeconomic ladder have not been lost on central banks. While central bankers often repeat lines such as ‘there are limits to monetary policy’, the Federal Reserve has consciously targeted a fuller level of employment. This approach is meant to counterbalance the disproportionate impact of boom and bust cycles on workers in low-skill jobs, who are much more likely to be out of work for a portion of the cycle and lag behind their contemporaries.

A fairer distribution of social outcomes is a laudable goal, but the implementation via monetary policy is not free from potentially damaging side effects. A key benefit of economic downturns is the proverbial ‘cleansing fire’, which destroys failing firms and leaves space for new growth in the coming expansion. As we approach the longest economic expansion in history, not only has no fire occurred, but central banks have installed a sprinkler system. The prospect of perpetual growth, falling borrowing rates, and diminishing likelihood of a downturn have all caused a repricing of risk. To put it more directly, when rates are forever falling towards zero, and the central bank will always defend the economy against a downturn, why not pile into assets, any assets, irrespective of risk or return? The central banks have created a new class of investor, the ‘zombie investor’ that will buy any asset.

Bottom line: Despite the perception that this policy stance can run indefinitely, it is an illusion. At some point, there will be a collective moment of clarity, an understanding that asset prices have diverged from fundamentals. The fact that risk assets are rallying alongside safe-haven assets, should say something about the dysfunction already in the system.  

GBP

Pivoting away from the news flow surrounding the Tory leadership contest, there is little data out to impact the Pound this week.  

  • CBI Realised Sales has markedly declined since last November, and no great improvement is anticipated on Tuesday since Brexit uncertainty persists. The data is expected to come in at 0.
  • Inflation Report Hearings on Wednesday are also not expected to reveal much since Bank of England (BoE) Governor Mark Carney is finishing out his term and fundamental data has softened of late, reducing the need for rate hikes.
  • With the weakening Pound and Brexit stockpiling over, Friday’s Current Account data can be used to gauge the pressure on Sterling in the current environment.

USD

While the geopolitical scene appears to be softening as markets open, there is some important US data out which has the potential to steal the spotlight.

  • Tuesday is an important day with three Fed members speaking. Now that a 25-basis point cut is already priced in for July, the potential for further policy clarification is ever-present.
  • Durable Goods Orders data on Wednesday—which measures purchases of higher value goods—will provide an opportunity to contrast against consumer confidence numbers which have steadily increased since 2009.
  • On Friday, the Personal Consumption Expenditure figures—the preferred Fed measure of consumer spending—and University of Michigan Consumer Sentiment numbers will be released.  

EUR

Last week’s EUR rally was driven primarily by USD selling, but having reached the trade-weighted 200-day moving average—a four-month high—economic data will be increasingly under the microscope. 

  • There is little data of consequence for the EUR until the Italian bond auctions on Thursday morning. Given the debate over Italian budgets, the yield and uptake among investors will reveal any flaws. 
  • On Friday Eurozone Consumer Price Index (CPI) estimates will be a key feature of the day heading into the weekend. Forecasted to come in near the two-year low, markets will be watching for signs of weakness.