The ECB and the Fed have shifted towards a more dovish stance because of concerns about global growth, the persistence of significant risks and the continued weakness of inflation:
- At its last committee meeting, the Fed scrapped its “patient” rate approach. The Fed will now “closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion”.
- At Sintra, Mario Draghi said: “in the absence of improvement additional stimulus will be required”.
Another important element: the high level of indebtedness after a decade of growth facilitated by ultra-accommodating monetary policies. According to McKinsey:
- Total debt (including household, non-financial corporate, and government debt) has grown by 75% since the financial crisis (from $97 trillion in 2007 to $169 trillion in H1 2017 in constant exchange rate terms).
- Government debt and Non-financial corporate debt account respectively for 43% and 41% of this increase.
In this context of high-level of indebtedness and low growth, the ability of central banks in developed countries to tighten their monetary policies has proved to be limited. We can now assume the normalisation is over and the Fed and the ECB are in easing mode:
- The Fed is stuck by market expectations. Given the high level of corporate and consumer debt, US economic growth will only stay on track if financial conditions remain accommodative and therefore only if markets are not disappointed by the Fed.
- The ECB is now running out of ammunition: the ECB will act to maintain financial stability and avoid the appreciation of the euro and, but new easing measures will also have collateral damage (banks, long-term fixed income investors, rising asset prices…).
The next question is about the ability of economies to sustain their economic growth through monetary easing and budgetary support. Notably, corporate profits are now slowing significantly. In the coming quarters, the sustainability of corporate debt could be critical and could end “bad news is good news” dynamic.