Opinion: Stimulus elsewhere is likely to offset Fed tapering

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The possibility that the US Federal Reserve will begin to taper its quantitative easing (QE) stimulus programme has understandably been the focus of much global debate and speculation in recent months.

While there is no denying the potentially negative impacts that the start of such a tapering process could have on many markets, there are a number of reasons that the fears of a resultant global economic decline, as expressed by many commentators, are actually unlikely to materialise in the foreseeable future.

In the first place, the actual likelihood of any significant QE tapering by the US in the near future is slim at best. The pace and composition of US economic growth remains too tepid and mixed to warrant the withdrawal of some stimuli from the system at this point.

Against this backdrop, if the US goes ahead with such tapering, this would almost certainly expose some of the lingering vulnerabilities in the economic recovery both in the US and the rest of the world.

Of course, despite the potentially negative repercussions of QE tapering, there is no certainty that this will stop the Fed from starting its proposed stimulus reduction early next year, albeit with the likelihood of a commitment to flat policy rates for an extended period.

However, even in the unlikely event that the Fed does take its foot off the gas slightly, there is far more to the global economy than just the US.

While the Fed is arguably the central bank that is closest to beginning to slow down the pace of its economic stimulus, there are a number of other economies – many of which are of greater direct importance to South Africa – that have yet to reach this point in their economic recovery processes.

The European Central Bank (ECB) is a case in point. Given the still very weak position of the euro zone’s macroeconomic indicators and the pedestrian pace of its economic recovery, it is highly likely that the ECB will continue, and even increase its efforts, to stimulate recovery for some time to come.

The recent rate cut from the ECB is unlikely to have a material and sustainable impact on turning around the regional economy. As such, the possibility of further stimulus – maybe even including the formalisation of QE or asset purchases in some form – will not only offset any gradual QE tapering in the US, but will undoubtedly also serve as a catalyst for continued global economic recovery, albeit at a gradual pace.

The joker in the pack, however, remains the Bank of Japan (BoJ), which has long been a driver of the global carry trade (where investors borrow money cheaply in the developed world and invest in higher-yielding climes).

Given the disproportionate focus on the Fed, the importance of the BoJ is being overlooked and could well serve to mitigate the negative impact of any QE tapering in the US.

A year ago, when the BoJ first announced that it would implement economic stimulus initiatives – including the effective doubling of the monetary base – the immediate result was a significant weakening of the yen from around ¥70 to the dollar to close to ¥100.

This devaluation in the Japanese currency by a third has proved beneficial for South African markets in that it has spurred risk appetite, thereby supporting emerging market assets, and helped to slow the weakening of the rand.

Rand weakness would have been even more pronounced in the absence of these measures and any further economic stimulus introduced by the Japanese is likely to have a positive effect on the South African economy and markets.

Given this combination of a strong possibility of continued economic stimuli from several key central banks with the fact that any tapering in US QE should be marginal for at least the first half of next year, it is likely that the result could be the resumption of positive tailwinds to capital flows providing support to this country’s bond market and, by extension, support for the rand as well.

So, while it is unlikely that South Africa’s economic recovery next year will be boosted by any significant improvement in domestic fundamentals, the potential certainly exists that it could derive significant benefit from a global reorganisation of economic stimulus focus. This is particularly as the developed world grapples with the proverbial Hydra of unprecedented monetary policy, which will be hard to unwind.

The difficulty of weaning global markets off the central bank teat will prove supportive of the South African economy, even if only in the short term.

If these additional stimuli occur, as expected, next year, South Africa’s economic recovery could very well circumvent any fallout from QE tapering in the US and resultant sell-off, and instead enjoy the reprieve that it so desperately needs.

* Mohammed Nalla is the head of strategic research for Nedbank Capital Global Markets.

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