Generally, the global macro-economic backdrop shapes the high-level decision making process for the investor community. Investment markets look into the future in terms of economic data by predicting economic trends and data releases and this outlook will shape the asset classes that investors will be either bullish [positive] or bearish [negative] on.
The majority consensus among investors then dictates the prices of asset classes and whether or not investors will be successful or not in their asset allocation strategies. A key measure that investors must consider is Central Bank monetary policy and if they will have an inflationary or deflationary effect. Monetary policy is the relationship between the rate at which money can be borrowed from the economy’s Central Bank and the supply of that money.
Monetary policy is defined as loose when base rates are low and Quantitative Easing [QE] measures are put in place to increase the supply of cash throughout the economy. Loose monetary policy is generally employed when an economy needs a kick-start and when more liquidity is needed in the system by making it more attractive to borrow funds and invest capital.
Globally we have been in a loose monetary policy environment for quite some time. Since the onset of the global financial crisis in 2007, central banks globally have added nearly US$ 10 trillion to their balance sheets. The US Federal Reserve has slashed its base rates to close to zero and expanded its balance sheet to US$3.3 trillion through QE. Similarly for the European Central Bank [ECB] with a record low base rate of 0.25% and the Japanese Central Bank which, after 20 years of deflation, has been given a new mandate to depreciate the Yen and to get inflation back up to 2% within two years.
Loose monetary policy is conducive to creating an inflationary environment. The extra supply of money means there is a greater risk of inflation. The main risk with inflation is that it can erode the purchasing power of an investor’s asset base or the cash flow from their assets.