Cut off by their sugar daddy

Investors fear the loss of central-bank support

Jun 29th 2013 |From the print editionTHE pattern is wearily familiar. In every year since 2010 global
markets have started the year in optimistic mood only to run into trouble in the late spring and early
summer. This time there is little doubt about the cause. The Federal Reserve has suggested that,
unless the American economy deteriorates, it may start to slow the pace of its asset purchases
currently running at $85 billion a monthlater this year. The purchases may stop altogether
sometime in 2014.Ever since the Fed began its latest round of quantitative easing (QE) last year,
investors have felt they had a one-way bet. As David Simmonds of Royal Bank of Scotland remarked:
In this period the imperative was to venture forth with liquidity and to find some risk-seeking home
for it, some extra yield, some enhanced return. This was a great rotation out of any remaining cash
and into anything and everything else.In this sectionStart me upCut off by their sugar daddyRolling
with the punchesAdminister with careA little less tangledDisparate timesLevying the
landReprintsRelated topicsQuantitative EasingMonetary PolicyPolitical policyEconomic
policyDomestic policyInvestors reacted to the potential loss of this support like trust-fund kids
warned that Daddy is about to cut off their allowance. They panicked. What is striking is the breadth
of assets that have fallen in price in recent weeks (see chart). Equities have dropped around the
globe, with some markets (including Chinas) now 20% below their recent peaks. Government bonds
have suffered: yields have risen sharply in safe, liquid markets like America and Germany, in troubled
euro-zone members such as Italy and Spain, and in developing countries. And there has been a rout
in the gold and silver markets, as well as a sell-off in economically sensitive raw materials such as
copper.Why would a reduction in the pace of QE by the Fed be a global problem? Other central
banks may compensate, after all. The Bank of Japan has started a programme of rapid monetary
expansion. There are hopes that Mark Carney, the new Bank of England governor, will ease policy.
Some believe that even the European Central Bank will eventually be forced into QE.One issue is the
dominance of American investors on the global stage. As Jim Reid, a strategist at Deutsche Bank,
comments: The problem we face is that the US tends to set the price of debt everywhere. With the
yield on ten-year Treasury bonds rising by a percentage point since early May, other yields have
been forced up in tandem. The effect is a global tightening in monetary policy. A spike in Chinese
money-market rates has not helped, especially as investors were already concerned about a
slowdown in Chinese growth.What makes the markets harder to read is that bond yields are rising
even though global growth forecasts have been revised lower and inflation is generally falling. This
may reflect the determination of investors to stay one step ahead of the authorities. Rationally, if
the end of QE is bound to result in a huge rise in yields, it makes sense to sell now rather than
later.But if yields rise far enough to dent the economy, or if stockmarkets collapse and undermine
consumer confidence, the Fed may be forced to keep QE going. (That explains why shares rose on
June 26th after a downward revision to Americas first-quarter GDP.) Markets tend to test things,
Richard Fisher of the Dallas Federal Reserve told the Financial Times this week, comparing investors
to feral hogsIf they detect a weakness or a bad scent, theyll go after it.The potential withdrawal
of QE support also forces equity investors to focus on the fundamentals, which are not that
supportive. According to Citigroup, downgrades of earnings forecasts are outpacing upgrades by a
ratio of three to two. Equities look cheap relative to government bonds but not in their own right:
the cyclically adjusted price-earnings ratio on the American market is 23.6, well above the historical
average.It is possible to put a positive spin on all this. The Feds hints of a tapering of QE, and the
subsequent rise in bond yields, may simply signal a return to normal. Although growth in developing
countries seems to have slowed, there have been better signs in the rich world: a good first quarter
in Japan, falling unemployment in America and even glimmers that the worst may be over in
Europe.The more bearish possibility is that the developed economies will struggle to maintain
momentum if emerging markets are slowing; that the rich world has still not managed to reduce its
high debt levels; and that the sell-off represents a recognition by investors that they are in deep
trouble without the crutch of central-bank support. It is a nice irony that the titans of fund
management, who consider themselves robust champions of the free-market system, are so
dependent on handouts from the monetary authorities.Economist.com/blogs/buttonwoodFrom the
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