Global liquidity party is alive and well – in charts

Global markets will still be dancing to a looser monetary beat

LONDON: Go on, order another one. Investors worried about the resilience of the global rally in the face of a recent selloff still have one big reason to keep on partying: Central banks haven’t yet taken away the liquidity punch bowl that has supported global asset prices for the past eight years.

In fact, real interest rates around the world are poised to fall in 2017 as inflation outpaces oncoming hikes in benchmark interest rates, creating a technical support that’s expected to be a boon for the global hunt for yield.

Global markets, in other words, will still be dancing to a looser monetary beat in the coming months in real terms. That stimulus could help offset rate hikes from the Federal Reserve, as well as concerns over stretched valuations and US President Donald Trump’s uphill battle to enact pro-growth policies.

Projections from Bank of America Corp paint a bullish picture of the liquidity landscape. The global interest rate adjusted for inflation will fall to 0.45% at the end of the year, compared with 1.08% currently, the bank forecasts.

“Central banks will remain very supportive of growth in the year ahead,” Ethan Harris, chief global economist at Bank of America Merrill Lynch, wrote in a client note. “Even with three Fed hikes this year, average policy rates for the countries we cover are expected to barely rise in nominal terms and dip when adjusted for headline inflation.”

The bank’s dovish projections take into account the average estimated interest rate of 46 countries weighted by their share in the global economy and adjusted for headline inflation.

For markets, an up-tick in inflation combined with low real yields constitute a sweet spot – for now. The S&P 500 has jumped on the hopes that a benign rise in prices will spur spending and investment, financed by a low effective cost of capital, though the rally faltered on Tuesday as the index dropped 1.24%.

Still, market optimism has helped to loosen financial conditions in the US since December even as shortterm borrowing costs advanced as the Fed hiked rates. Credit spreads have fallen, while the US dollar has struggled to maintain its post-election ascent this year. That constitutes stimulus to the global economy that offsets the tightening cycle.

“At current levels, financial conditions are poised to make a substantial positive contribution to growth in 2017, from a starting point of essentially full employment, inflation close to the target, and a sub-1% funds rate,” economists at Goldman Sachs Group Inc said last week.

Dovish projections over the Fed’s medium-term tightening cycle have emboldened market bulls. Based on traditional metrics, such as the Taylor Rule, the Fed’s overnight target rate appears too low relative to current price conditions. The gap between the Fed funds target rate and the cost of money indicated by that rule hit the highest level since the 1970s right before the rate increase last week.

It’s not just about the US central bank, though. Ongoing stimulus programmes at the European Central Bank and the Bank of Japan are still driving almost US$200bil of asset purchases a month, according to Deutsche Bank AG estimates.

Low real rates in the developed world have helped buoy capital flows in emerging markets this year as investors flock to the higher real rates on offer. — Bloomberg