Economics & Strategy
The Global Reflation Party Continues
—David Zervos, Global Head of Fixed Income Strategy
Last quarter we ended our outlook with the following: "Central banks will continue to be the ultimate backstop against the European chaos. This is why we continue to believe in a bullish risk asset reflationary trade. Yes, there will be a period of continued uncertainty, but we should never underestimate the power of global reflationary policies. From Bernanke, to Shirakawa, to Draghi, fingers are all on triggers. And the central bank bazookas are the most powerful guns on the battlefield."
Since then, the Fed, ECB and Bank of Japan (BoJ) have delivered well beyond expectations. The Fed introduced open-ended QE, committing to buy $40 billion per month in Agency MBS until the unemployment rate falls toward the natural rate. The Fed extended its low-rate guidance to 2015. The ECB introduced a new targeted form of monetary policy easing called "Outright Monetary Transactions" (OMTs). In exchange for fiscal parsimony, member states can now receive preferential monetary policy accommodation from the ECB. Finally, the BoJ continued to expand its balance sheet, using BBB-rated nonfinancial corporates, REITs and equity ETFs. Their expansions have been above and beyond market expectations.
We continue to see a favorable environment for risky assets in a world where central banks are aggressively expanding their balance sheets and diluting the value of money. To be sure, there are plenty of shocks that could temporarily harm the performance of risk assets. While the fiscal cliff, a Greek exit and geopolitical risks in Asia and the Middle East all may generate pullbacks, these will create opportunities to once again profit from the central bank back stop. We will not see the major central banks allow deflation to mix with the excessive levels of debt. In the end, the obsession with fighting deflation will lead to an increased risk of inflation. As such, we continue to favor all asset classes that cannot be diluted by central banks.