Monetary Morphine

Call it monetary morphine. The market has become addicted to receiving regular doses of help from central banks.
Be it quantitative easing by the US Federal Reserve and Bank of England or the European Central Bank’s bond-buying and cheap loans for banks, risky assets such as equities have responded positively to any support over the past four years even if the sugar high has eventually worn off.

But this week has been rather revealing as all three western central banks have refused to provide extra stimulus, at least for now. Equities have still rallied with the S&P 500 up about 4 per cent on the week after coming close to touching its lowest point of the year last Friday. It all had the air of a “phoney war” as one analyst described it.
Many investors are sceptical about the benefits of more action by monetary authorities, especially as government bond yields – the main tool used by the central banks – have all recently touched historic lows.
“If you look at the last couple of years, central bank intervention in the US has led to improvement in risk assets but it has then fizzled out … In the US, and UK, there probably are diminishing returns to QE for asset markets,” says Andrew Balls, head of European portfolio management at Pimco, one of the world’s largest bond fund managers.
But monetary morphine was provided to the markets this week, and from an unexpected quarter: the People’s Bank of China on Thursday cut interest rates for the first time in four years.
For some optimists, this suggests that central banks in emerging markets – where official interest rates are generally much higher than the record lows at the Fed, Bank of England and ECB – still have the ability to support the global economy if necessary.
But for pessimists – who can point to falls in nearly all Asian markets on Friday – the move is potentially alarming as it underlines how worried Beijing is about slowing growth.

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