Central bankers in the US and Europe are at risk of making “a significant policy error” that could lead to a recession, according to fund manager Neil Woodford.
While the prospect for a recession in the US by 2020 has been speculated for a while now, many less bearish commentators have been consoled by the US Federal Reserve’s insistence that their withdrawal of quantitative easing and interest rate hiking cycle will be slow and steady.
However, investors’ fears over a potential hawkish policy mistake by the Fed or European Central Bank are rising. Almost a third of respondents to Bank of America Merrill Lynch’s May Fund Manager Survey cited this as the biggest risk to markets, up from 22% in April.
And Woodford, manager of the Morningstar Bronze Rated Woodford Equity Income fund, says there’s a distinct possibility the Fed and ECB will withdraw their “extraordinary monetary policy too soon or too fast, with obvious economic and market consequences”.
In his latest blog, Woodford notes that despite the purpose of QE being to push down interest rates, the policy has actually had the opposite effect. “During every single period of QE, long-term interest rates rose – they did not decline,” he asserted.
“Over the entire period of extraordinary monetary policy [post financial crisis], bond yields fell, but this was as much to do with declining inflation and low growth as it was to do with the policy itself.”
Bond yields rose during these periods because, all else being equal, QE is inherently inflationary, continues Woodford. The Fed is currently now in tightening mode and, if QE is inflationary, then quantitative tightening should, by implication, “increasingly exert deflationary pressure on the US economy”.
“We are already starting to see the impact of QT in global liquidity conditions. We believe central bankers should be paying more attention to the very close relationship between money supply and nominal GDP.”
On a more positive note, Woodford took the opportunity to re-iterate his bullish view on the UK. He noted that it is the one developed economy whose central bank is not facing the challenge of managing the wind-down of "extraordinary monetary policy".
“The UK economy has sustained nominal broad money supply growth of around 5% per annum recently,” he says. “This, coupled with all the other positive trends in the UK economy that we have been highlighting, is enough to suggest that domestic growth can accelerate in the months ahead.”
As a result, he claims, consensus expectations for the UK economy are still looking “far too low”.
