What if you needed a shot of adrenaline – a hormone that makes your heart race and that’s part of the human “fight or flight” defense – just to get out of bed in the morning? That’s what it’s like for the global economy.
The release of adrenaline is the body’s response to a highly stressful situation – which is what the global economy faced during the global economic crisis of 2008-2009. The world’s central banks delivered an adrenaline regime of record-low interest rates and quantitative easing to stabilize the global economy. As a result, in recent years many countries have experienced a long period of low interest rates, as the graph below shows.
Eight years later, the global economy is addicted to central bankers’ adrenaline. The question is whether ever-greater doses of adrenaline will still work, or for how much longer.
Last week, Mario Draghi, the European Central Bank president, announced an increase in its quantitative easing programme. The ECB is also cutting already-negative deposit rates that it charges banks to keep their reserves, to negative 0.4 percent. That means that the ECB is actually charging banks to keep their money.
Two weeks ago, China’s central bank, the PBOC, cut its banks’ reserve requirement ratios (which is the amount of cash banks need to hold as reserves) by 0.5 percent. It’s the fifth time in the past year the PBOC has cut the reserve rate. The cut means that banks in China will be able to lend out more cash.
The ECB and the PBOC are worried about slowing economic growth. They hope that their efforts will motivate banks to lend more money – which in turn will drive growth.
Meanwhile, in December, the U.S. central bank, the Federal Reserve, started to move in the opposite direction. It ended QE and raised the Fed funds interest rate (which is the interest rate it charges when it lends money to other U.S. banks) for the first time since June 2006. This was like cutting the dosage of adrenaline by a few milligrams. And at the time the Fed indicated that it would raise interest rates four times during 2016.
But, as we predicted in January, those plans are now in doubt. In fact, it now looks more likely that the next Fed move will be to cut rates. Federal Reserve head Janet Yellen has said that the central bank is studying whether negative interest rates would help if things get worse.
If what the U.S. Treasury bond yield curve is saying is correct, things probably will get worse. The bond yield curve has a good record of predicting recessions, and what it’s saying now is that the U.S. economy will need to go back to a full adrenaline dose. And when the U.S. economy – a big source of demand for Asia – falters, this part of the world suffers as well.
More adrenaline would probably be good for stocks. The global bull market that followed the global economic crisis was fueled by the measures taken by central banks around the world to jump-start growth. And that bull market faltered when central banks – some of them, at least – suggested that their support (via QE and other measures) was going to taper off.
But what’s good for stocks now would not be good for stocks for long. After a while, the adrenaline starts to wear off, and it takes more to achieve the same result. It becomes more difficult for the patient to get out of bed in the morning. And that’s certainly bad for stocks.
What can you do in the meantime? Watch your stop-loss levels very closely. Buy assets that have a low correlation to each other. And make sure to buy more gold, which is viewed as a safe haven when markets, and economies, are in trouble. The easiest way to get exposure to gold is through an ETF, like the SPDR Gold Shares ETF (Singapore, code: O87), or the Valuegold ETF (Hong Kong, code: 3081).