Troy’s Lyon: Fed may not be able to stop deflationary shock

The latest round of QE from the US Federal Reserve may not be enough to prevent the global economy from experiencing a deflationary episode, according to Sebastian Lyon, manager of the £2.2bn Troy Trojan fund.

Lyon (pictured) said the fresh instalment of asset purchases, announced by the Fed last month, does not constitute the much-debated monetary policy “bazooka” – despite Fed chair Ben Bernanke committing to “open-ended” easing.

With markets displaying little reaction, in contrast to the response to earlier rounds of QE, Lyon suggested central bankers’ ability to stave off more serious short-term issues is waning.

“Central banks are falling victim to the law of diminishing returns. Optimism has been replaced with cynicism as newly printed money has largely failed to make it into the wider economy.

“While inflation is the ultimate threat, a deflationary shock in the short term cannot be ruled out.”

Hopes for a stronger global economic recovery have gradually faded this year despite the strong rallies enjoyed by most stock markets. The IMF this week downgraded its global growth forecasts for the second time since April.

While most of the focus has remained on the US and European economies, the effects of a slowing China and lower commodity prices mean the likes of Australia are at risk of their own ‘deflationary shock’ in the next 18 months, government ministers there have warned.

Lyon said the global race to weaken currencies is continuing apace, in an echo of the policy actions of the 1930s.

“Few central bankers want a strong currency and there is a whiff of the beggar thy neighbour policies of the 1930s.

“The critical part to these announcements was the Fed chairman’ s commitment to ‘open-ended’ QE. On this basis, there will be no QE4, 5 and 6, just a gradual (or rapid) increase in base money as desired.”

The Troy Trojan fund has returned 36.9% over the three years to 3 October versus an average return of 17.3% for its UK Flexible Investment sector peers, according to Morningstar. Over five years it has returned 50.6% against a sector average return of 6.2%.

 

This article was first published in Investment Week

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