Is the Era of Cheap Money Coming to an End?

Last week, global stock markets traded very uncertainly due to investors’ fears that the era of extremely loose monetary policy, which leading central banks around the world have long supported capital markets, is coming to an end.

On Wall Street last week, the Dow Jones index weakened by 1.2 percent to 15,070 points, while the S&P 500 slipped by 1 percent to 1,626 points, and the Nasdaq index fell by 1.3 percent to 3,423 points. This marks the third decline in the index in the last four weeks.

This is a consequence of uncertainty regarding the Fed’s monetary policy. By purchasing government and mortgage-backed securities worth $85 billion per month, the U.S. central bank has long injected cheap money into financial markets, which is the main driver of stock price growth.

Since three weeks ago, when Fed Chairman Ben Bernanke stated that a discussion about reducing these bond purchase programs could take place at one of the upcoming central bank meetings, investors have been unsettled as this would mean the market would lose significant support.

“Investors are concerned about the possibility of a reduction in the Fed’s stimulus programs and how that would affect the market. The level of uncertainty has risen dramatically in recent weeks, and the perception of increased risk could lead large players, such as funds, to sell, which would further pressure stock prices,” says Paul Zemsky, director at ING Investment Management.

Last week, investors were further troubled by the decision of the Japanese central bank to keep its monetary policy unchanged for the time being.

In April, the Bank of Japan adopted stimulus measures that will inject $1.4 trillion into financial markets over the next two years and indicated that it would further ease monetary policy if necessary.

Therefore, investors hoped that the central bank would announce additional measures. However, as it did not do so, the question arises whether this is a shift in central bank policies, is the era of cheap money coming to an end?

“Now some central banks are signaling that we should expect less from them in the future. By not further easing monetary policy, the Japanese central bank has also sent us this message, and the weakness of stock markets worldwide shows how unsettled investors are,” says Kevin Caron, strategist at Stifel, Nicolaus & Co.

Since the beginning of the year, the S&P 500 index has risen by more than 14 percent, reaching its highest levels in history in May.

“Strong stock price growth has been driven by good corporate earnings and signs of improvement in the economy, but in the background, there has always been the idea that cheap money from central banks would support price growth,” says Kevin Caron.

The strong rise in the VIX index of the Chicago Board Options Exchange indicates investor uncertainty. This so-called ‘fear index’ rose by more than 15 percent last week, showing that investors are increasingly hedging their portfolios against possible further declines in stock prices.

Market uncertainty is expected to prevail, analysts predict, until the end of the two-day Fed leaders’ meeting next week and Ben Bernanke’s press conference.

“Bernanke has become the ‘whisperer to the market.’ He knows that reducing stimulus measures is necessary, but he also knows that the market will not wait for the Fed’s decision. Therefore, Bernanke will likely try to calm the market and clarify that he does not intend to reduce stimulus anytime soon,” says Quincy Krosby, analyst at Prudential Financial.

European stock prices also fell last week. The London FTSE index weakened by 1.6 percent to 6,308 points, while the Frankfurt DAX slipped by 1.5 percent to 8,127 points, and the Paris CAC fell by 1.7 percent to 3,805 points.

On the Tokyo Stock Exchange, the Nikkei index fell by 1.5 percent last week to 12,686 points, marking the fourth consecutive week of decline.