QE addiction among ongoing risks spotted by AXA IM’s Chris Iggo
Chris Iggo, CIO Fixed Income at AXA Investment Managers, has identified addiction to quantitative easing (QE) as a key ongoing risk to fixed income investors.
Since central banks began their great monetary experiment it has become increasingly clear that quantitative easing (QE) has become the dominant influence on valuations and investor flows in almost all parts of the financial markets.
It is now difficult to distinguish between the symptoms of the “risk-on risk-off” volatility of markets with those of changing policy guidance and investor expectations about the future of QE. This has helped create a cleft between economic fundamentals and asset prices and introduced a significant amount of risk into the markets.
The risk is that this gap will close, most likely through a fall in prices. It has been quite easy to detect the following “market thought-process” on many occasions – weak economic data leads to expectations that central banks will keep on pumping liquidity into the markets in order to keep the risk-free yield extremely low. As a result, risky assets rise in price.
Conversely when it looks as though QE might actually be getting some traction in the real economy and we get stronger data points, markets sell off because of the fear that central banks will take away the punch-bowl.
The impact of QE has not just fallen on the government bond markets of those countries where central banks are actively pursuing an asset purchase programme, although it is here that the most direct impact is seen as bond yields are much lower than they would be in the absence of QE. Even the Fed has estimated that QE has delivered yields of 100bp lower than would have otherwise been the case.
The influence of policy goes beyond the government bond market. Lower underlying yields have benefitted all fixed income asset classes and the crowding out of investors from government bonds into spread products has led to credit spreads narrowing and total returns from bonds being well above their longer term averages. Lower bond yields also raise current equity valuations, especially when combined with elevated expectations of future earnings growth (i.e. that QE will work on the economy). More and more of us in the markets are saying that investors have become hooked on liquidity and that there is a period of cold turkey coming.