It’s a central bankers’ world, and we’re all just living in it.
Entities such as the Federal Reserve and the European Central Bank in 2012 took control of global economies like never before. Based on current market and economic behavior it’s likely to be years before anything changes.
After all, how can central banks take their foot off the stimulus pedal when there’s so much at stake?
In all, 13 other central banks in the world have followed the Fed’s lead and set interest rates at or near zero in an effort to keep the liquidity spigots open and prop up their ailing economies. Those 14 economies represent a staggering $65 trillion in combined equity and bond market capitalizations, according to Bank of America Merrill Lynch.
As for the bond-buying programs – aka quantitative easing – that dovetail with the low interest rates, the U.S. central bank alone shortly will eclipse $3 trillion on its balance sheet and is expected to end 2013 north of $4 trillion in electronically created money. (Read More: Fed to Keep Easing, Sets Target for Rates)
Globally, that figure is, well, a lot.
“When you add up all the central banks in the world, it’s going to be over $9 trillion,” said Marc Doss, regional chief investment officer for Wells Fargo Private Bank. “That’s like creating the second-largest economy in the world out of thin air.”
Indeed, central banking has become an economy unto itself, a multi-trillion-dollar empire that massages and manipulates markets, which respond to the slightest news out of the respective entities’ policy making committees.
And if you’re looking for the off-ramp, a point at which the central banks let the free market to its own devices, don’t hold your breath.
Fed Chairman Ben Bernanke and the central bank’s Open Markets Committee said Wednesday that rates will remain near zero at least until unemployment drops to 6.5 percent and inflation rises to 2.5 percent. (Read More: Job Creation Hits 146,000, Rate at 7.7%)
If current trends are any gauge, either occurrence is likely to take years.
In the meantime, equity markets remain tethered to Fed policy, dropping in part on Wednesday’s news over fears that the Fed isn’t doing enough.
In fact, otherwise bullish Bank of America strategists say the main risk to stocks next year is the economy improving significantly, as that might spur the Fed to dial down the extraordinary measures it is taking to keep the American growth engine purring.
“The most obvious reason for the ongoing rally in risk assets is the largess of major central banks. Policy continues to be a major driver of risk appetite,” Michael Hartnett, BofA’s chief investment strategist, said in a report. “With so much investment flow predicated on QE-infinity, and the maintenance of zero interest rates, anything that disturbs the liquidity outlook is likely to increase volatility.”
“We worry that the strong performance of banks, value, (real estate investment trusts) and bonds and the underperformance of cash make bond and equity markets vulnerable to any upside growth surprises in (the first half of 2013), as this would likely lower liquidity expectations,” he added. (Read More: Why BofA Thinks Stocks Will Hit New High in 2013)
The result of such widely shared sentiment is an upside-down world for investors.
Whereas those looking to put money to work in the equity markets could simply look at a company’s fundamentals and price action then act accordingly, a world where aggressive central bank policy will be at play indefinitely and immeasurably changes the entire landscape.
Yes, monetary policy always has been important to the markets, but not like this.
“We have never seen investors so nervous after such a strong market. We would have expected greater enthusiasm,” Deutsche Bank’s strategists said in an analysis. “If the Fed were to leave (policy) alone and let markets decide, then equity markets would probably fall. But, as it is, if real investors can’t predict which way markets will go, then they will stay on the sidelines.”
Gripe though they may, however, investors are not apt to swim against the tide.
None of the major Wall Street houses is betting against the stock market in 2013, reasoning that equities will be pushed forward by a modestly strengthening economy and continued Fed accommodation. (Read More: Why Has Wall Street Gotten So Bullish About Next Year?)
Hedge fund manager Blackrock is virtually alone in its assessment that Fed tightening actually could send money into equities – in a “dash for trash,” the firm said – while most others believe central bank liquidity is key.
JPMorgan Chase, for one, correctly anticipated that the Fed would tie its policy to specific economic targets – in part as an effort to counteract the political and fiscal mess in Washington.
“This change in communications should further cement the view that rates won’t be rising for a very long time. We think the first hike won’t occur until late 2015, or possibly even later,” JPMorgan’s chief market strategist Thomas J. Lee said. “The continued gentle posture of monetary policy should keep financial conditions supportive, helping to offset some of the drag imposed by fiscal policy.”
The mindset has led managers dangerously up the ladder in risk, particularly in the high-yield area of fixed income. Though they saw outflows in November, junk bond mutual funds have seen assets under management grow 19 percent this year as investors grope for yield in a no-yield environment.
Wells Fargo’s Doss said he is afraid of high-yield in corporate debt but favors it in municipal bonds, and otherwise is putting focusing on risk in the equity and commodity markets.
It’s all part of the brave new central banking world.
“We’re in open-ended QE across the globe,” Doss said. “I don’t know what the end game is.”
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