JP Morgan Asset Management has released a new Investment Insights paper that looks beyond the near-term forecast of the Federal Reserve's next rate hike or the European Central Bank's next round of asset purchases to explore what developed market monetary policy could look like in future business cycles.
The paper also explores how central banks might deploy quantitative easing, negative interest rates or 'helicopter money,' and what this implies for multi-asset investors and global markets.
The paper – "The Future of Monetary Policy" – examines the future of novel central bank policy approaches to realising their mandates of price stability and full employment and finds that policies similar to quantitative easing are here to stay. Born of necessity in the aftermath of the financial crisis when central bank overnight lending rates hit zero, quantitative easing emerged to repair markets and ease financial conditions. QE worked and will likely be deployed again in the next downturn.
The process of experimentation with "unconventional" policy will continue so long as the policy interest rates that central banks set stay close to zero. One idea that has gained traction is "helicopter money," disbursing money directly to banks (and indirectly into their customers' accounts). Such unconventional policies need to balance the need for economic stimulus with the risks to central bank political independence, but it is fair to say that they are more plausible alternatives in today's economy than they used to be.
The central banks' more active role and the use of quantitative easing, in particular, imply that yield curve steepening and flattening in subsequent business cycles will be more moderate. The inversion of the curve, when long-term rates rise above short-term rates, a historical precursor to recession, may no longer happen.
"All of these developments are a mixed blessing for multi-asset investors," says Ben Mandel, Global Strategist, JP Morgan Asset Management, "On one hand, central banks are finding ever more diverse and creative solutions to achieve their mandates. On the other, it suggests that the warning bell coming from the Treasury yield curve will be less informative than it used to be about the most worrisome outcomes, when the economy tilts into recession. In our view, variations in quantitative easing among central banks will continue to define the degree of monetary policy divergence in the coming years."
"The entire spectrum of conventional and unconventional policies has shifted in the past few years, blurring the lines between fiscal and monetary policy and raising questions about central bank independence," continued Stephanie Flanders, EMEA Chief Market Strategist, JP Morgan Asset Management. "Arguably, central bank-financed fiscal stimulus – helicopter money – would be the logical endpoint of this progression. If another downturn threatens while policy rates are still close to zero and central bank balance sheets are still enlarged, it is a reasonable assumption that at least one central bank abandons the pretence and helicopter money will complete its move from the unthinkable to the merely unconventional."
"It is fair to say that current policies are less 'unconventional' than they used to be," says Thushka Maharaj, Global Strategist, JP Morgan Asset Management. "The drawback, however, remains that the same attributes that make today's policies compelling could also ultimately spell out their limits in the long term."