Federal Reserve chairwoman Janet Yellen will speak at the annual Jackson Hole Symposium in two days. The financial market is closely watching for clues for the next meeting of the Federal Open Market Committee.
Some might argue that the Fed may start shrinking the balance sheet but at a small scale. Does that mean the financial market does not have to worry about the potential impact?
I do not think so. The current high asset prices are underpinned by a low interest rate environment, and there is a risk that the US, Europe and China could be tightening at the same time.
As long as the cost of money stays low, investors would be happy with low return, even if that return is just 3-5 percent. That is the situation we have witnessed in the property market for example.
But if the Fed’s upcoming move drains away market liquidity, and the 10-year Treasury yield returns to above 3 percent from 2.1 percent at the moment, investors may need to do their maths again, and probably they would opt to postpone of even give up some of their investment plans.
Monetary easing by global central banks has played a critical part in inflating the valuations of bonds, properties and stocks over the past few years.
How would asset prices respond if central banks start to tighten liquidity?
While the market is waiting for more hints from Yellen, China has already shown clear signs of a tighter monetary environment.
The nation’s broad money supply or M2 growth slipped to 9.2 percent in July from about 13.5 percent one year ago. The growth pace is expected to fall further to 8 percent next year.
If you are a mainland investor, you will find it’s more difficult to get mortgage loans, and developers may also find it hard to secure financing for their new projects.
Meanwhile, Europe also posted robust economic growth in the first half of the year. Therefore, the European Central Bank is very likely to wind up its QE before the end of the year.
That means three major central banks could soon be tapering simultaneously.
The danger is investors are already used to extra-low interest rate, and they almost forget about the risk of rising interest rate.
This article appeared in the Hong Kong Economic Journal on Aug 23
Translation by Julie Zhu
[Chinese version 中文版]
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