WWRR Vol.2.015

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2019 Global Economic and Market Outlook Ric Deverell +61 2 8232 4307 ric.deverell@macquarie.com Hayden Skilling, CFA +61 2 8232 2623 hayden.skilling@macquarie.com Matthew Turner +44 20 3037 4340 matthew.turner@macquarie.com The end of global QE: Keep calm and carry on Since monetary policy normalisation became a real prospect in advanced economies, there has been much debate about its likely effects on asset prices. A common conviction was that markets had been artificially supported by aggressive central bank asset purchases, and that valuations would drop as the rate of balance sheet expansion slowed – a topic we discussed earlier this year in Does peak QE signal peak asset prices?. As it turns out, while global equity markets have been buffeted by a range of factors in 2018, the slowing in central bank balance sheet expansion appears to have been less important than many had feared, with political uncertainty and the US-China trade war taking centre stage. However, with slowing balance sheet expansion having now turned into stabilisation (or even outright contraction on some measures), concern has re-emerged that this could trigger a slide in asset prices. In this section, we update our views on the expected path of major central bank balance sheets and the implications for asset prices. Our estimates suggest that over the next year or two, the extent of balance sheet reduction by the G4 central banks will be relatively small, with a continued contraction in the Fed’s balance sheet largely offset by ongoing BoJ expansion. Contrary to the fears of some, this in and of itself should not lead to a sharp fall in asset prices, as the relationship with central bank assets (both in terms of levels and net purchases) is much weaker than often claimed. 2 This is consistent with our view that the withdrawal of extraordinary monetary policy accommodation will only occur against a relatively robust economic backdrop, which itself should be supportive of risk asset prices, despite the concomitant rise in bond yields. The flip side of this, of course, is the likelihood that if growth were to slow, the tightening would be reversed. Central bank balance sheets The Fed As discussed in the US outlook below, US GDP growth is expected to remain robust over 2019, with underlying wages growth and inflation continuing to pick up, leading to a continuation of the Fed’s monetary policy normalisation. As such, we expect: The Fed to increase the fed funds rate by 25bps in December and then 3-4 more times over the course of 2019. The current pace of balance sheet normalisation to continue, with holdings of Treasury securities and agency debt/mortgage-backed securities running off at a maximum monthly rate of US$30bn and US$20bn, respectively. This to see the Fed’s balance sheet shrink at an average rate of around US$40bn per month through until end-2020. Fig 46 The recent pace of Fed balance sheet contraction is expected to continue through until at least the end of 2020 US$tn 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Federal Reserve Assets 0.5 Forecasts 0.0 03 05 07 09 11 13 15 17 19 Source: Macrobond, Macquarie Macro Strategy Fig 47 On average, this should see the Fed’s balance sheet shrink by around US$40bn per month US$bn 100 80 60 40 20 0 -20 -40 Federal Reserve Assets Net purchases 12-month moving average Monthly -60 14 15 16 17 18 19 20 Source: Macrobond, Macquarie Macro Strategy Forecasts 2 For consistency across countries, “net purchases” here refers to the change in total central bank assets, as opposed to net additions under specific asset purchase programmes. 4 December 2018 27
2019 Global Economic and Market Outlook The ECB While our growth outlook for the Eurozone has been revised downward on the back of weakerthan-expected growth in 2018, wages and consumer price inflation are showing signs of life. As such, our outlook for ECB policy has not changed significantly, and we continue to expect: The ECB to end its asset purchase programme in December, consistent with its publicly stated plan, but for the size of the balance sheet to then remain stable through 2020. Progress on the inflation front to be gradual, with a rate hike unlikely to be on the cards until early 2020. Fig 48 The ECB’s balance sheet has more than doubled since 2015, but the pace of expansion has slowed recently EUR tn 5.0 4.5 4.0 3.5 3.0 2.5 2.0 ECB Assets Fig 49 We expect the ECB’s asset purchases to end this year, but do not expect a balance sheet rundown any time soon EUR bn 120 100 80 60 40 20 0 ECB Assets Net purchases Forecasts 1.5 1.0 -20 -40 Monthly 12-month moving average 0.5 Forecasts 0.0 03 05 07 09 11 13 15 17 19 Source: Macrobond, Macquarie Macro Strategy -60 -80 14 15 16 17 18 19 20 Source: Macrobond, Macquarie Macro Strategy The BoJ While we are now seeing some signs of a pick-up in wage inflation in Japan, which we expect to spill over to broader inflation, it is likely to be some time before underlying inflation sustainably approaches the BoJ’s 2% target. As such, we expect: The BOJ will continue to target a low 10-year yield, however it could continue to gradually widen its trading band (which is currently zero ± 20bps). The pace of net asset purchases, which has been running at around JPY30 trillion per year since the beginning of 2017, to continue at around current rates. However, with global yields rising, it is possible that the BoJ may need to step up asset purchases to retain credibility. Fig 50 The pace of BoJ balance sheet expansion has slowed since 2016… JPY tn 700 600 500 400 300 200 100 BoJ Assets Forecasts 0 03 05 07 09 11 13 15 17 19 Source: Macrobond, Macquarie Macro Strategy Fig 51 …with the recent pace of expansion expected to continue through to 2020 JPY tn 14 12 10 8 6 4 2 0 -2 -4 Monthly BoJ Assets Net purchases 12-month moving average -6 14 15 16 17 18 19 20 Source: Macrobond, Macquarie Macro Strategy Forecasts 4 December 2018 28
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WWRR Vol.2.015

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