22 February 2019
The European Central Bank is likely to expand its quantitative easing program. Photo: Bloomberg
The European Central Bank is likely to expand its quantitative easing program. Photo: Bloomberg

Financial market turmoil looms as more QE expected

It appears that major central banks intend to ramp up their monetary easing.

It’s a sign that major economies have overly relied on quantitative easing (QE) to stimulate flagging economic growth.

It’s not good news for markets, in particular for Hong Kong, China and other emerging markets, given that the US Federal Reserve has yet to launch a QE4.

At a meeting on Oct. 22, European Central Bank president Mario Draghi hinted that the central bank will expand its QE program.

The ECB has purchased 60 billion euros (US$65.56 billion) of bonds since the start of the year, and it is expected to inject 1.1 trillion euros of liquidity into the market in the next 19 months until inflation climbs to 2 percent.

Market participants also expect the Bank of Japan to further expand its stimulus program as early as this Friday.

If both the ECB and BOJ step up their monetary easing in the short term, such actions could trigger a second rally for the US dollar.

In fact, the financial market turmoil in recent months has stemmed from the US dollar strength, as well as from declining commodity prices and capital outflows from emerging markets.

A fresh rally in the US dollar could create more volatility.

The US dollar index has already shown strong upward momentum after signs of QE expansion in Europe last Thursday.

The euro and the Japanese yen account for over 70 percent of US dollar index. The US dollar risk reversal also spiked from the bottom recently, suggesting that investors are again bullish on the greenback.

Meanwhile, the CRB Commodity Index, crude oil prices and related currency and emerging market currency indices have all moved downward.

It seems another financial crash is looming as the ECB and BOJ ramp up their stimulus programs.

Hong Kong investors are worried that the financial market volatility could make things worse in China.

Chinese version of QE

Currently, China is grappling with two main issues, economic slowdown and continued capital flight.

These issues are becoming more complex as the Chinese renminbi won’t be allowed to depreciate sharply after the reform of daily fixing in August.

However, the Chinese currency might face more downside risk as commodity prices and emerging market currencies will be weighed down by further US dollar rally.

The People’s Bank of China has expanded a pilot re-lending program, which might pave the way for the launching of a Chinese version of QE.

The Chinese central bank would continue to stimulate growth through interest rate cuts and reserve requirement ratio reductions.

However, it might also resort to a Chinese version of QE eventually given the structural issues and external market volatility.

That could create a dilemma for Beijing to launch QE without a deep devaluation of the redback.

If Beijing launches QE, the Chinese yuan is likely to weaken sharply. That might trigger a currency war and lead to financial turmoil.

That might exert huge pressure on both Hong Kong and China markets.

However, if Beijing chooses to defend its currency, it could face great challenge in stimulating growth. That could again weigh on equity markets.

The financial market is set to become more volatile next year given the second round of US dollar rally.

This article appeared in the Hong Kong Economic Journal on Oct. 29.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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