Quantitative easing (QE) has resulted in heavily indebted developed economies and has had varying degrees of success. The question now for QE is not about how much, but how much longer?
As these unprecedented efforts to stimulate developed markets have largely run their course, it is time to look at the likely next steps of central banks and how a return to more normal market conditions could impact markets.
Despite a fairly uniform decision to undertake QE across developed markets, the methods used have differed and so will the approaches to unwinding in the US, UK, Europe and Japan. Taking these four in turn, we will examine the route back to normality.
US
The US is arguably closest to winding down the effects of QE and will set the pace for the rest of the world. The last QE programme was completed in 2014, by which point the Fed had amassed a portfolio of $4.5 trillion - it has maintained this level by rolling over the debt and reinvesting the principal, while beginning to normalise interest rates with a few quarter point rate rises.
The Fed is treading softly with regard to reducing this vast sum, seemingly in a bid to avoid a repeat of 2013's ‘taper tantrum', as it provides a buffer to absorb economic shocks while the economy remains seemingly fragile. Tapering is still likely at some point; possibly by the end of 2018. It will follow a gradual path to avoid shocking the markets but we would nevertheless expect to see some upward pressure at the long end of the yield curve. We can expect rate rises to tick up in the meantime.
UK
If the US leads, the UK will probably follow next, but this will be more complicated. Such is the dependence on central bank largesse by banks to meet their regulatory capital buffers, that any withdrawal of QE will have severely detrimental effects.
The UK has also had the misfortune of suffering from some of the unintended consequences of QE. House prices have been inflated out of all proportion, inhibiting many first time buyers, while many defined benefit pension schemes are at risk as the present value of long-term future-defined benefit pension liabilities has risen to the point that they are mismatched with the pension assets that have been hindered by the lower rates and higher asset prices.
An unwinding of QE or an interest rate rise at this stage would be a bold move with Brexit on the horizon but the longer that things stay this way, the country is at risk of having minimal tools to use if another crisis were to take place.
Europe
Geopolitical concerns and elections continue to steal the show in Europe but for now the populism craze seems to be going out of fashion, though the ECB is heavily exposed should there be a further fracturing of the European Union. Europe is still only just over 80% of the way through its latest extension to QE but a positive growth story means that this could be the final phase, not forgetting the fact that the ECB is running out of bonds to buy. The deflation risk is fading and so Draghi will now be looking to complete QE and perhaps start tapering by the end of 2018.
Japan
Japan was the first to use QE in 2001 and may be the last to finish such is the perpetually low inflation rate. Positive lessons will be taken from the way that Japan unwound QE in 2006 as it showed that it could be done in a smooth and controlled manner without adversely destabilising the markets. It feels like years since ‘normal' economic conditions have been seen in Japan - maybe they will surprise us all and move first again?
QE has served its purpose for now and provided a lifeboat for developed markets but in order for it to be effective again in the future, economies will need to be weaned off the easy money supply and left to stand on their own feet.
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