Central Bank Accommodations

A key driver increasing the likelihood of strong equity gains in 2012 is global monetary policy. On balance, the world's central banks remain very accommodative—some acting quickly to provide liquidity when funding markets show signs of stress. Though time will tell whether recent actions ultimately prove wise, for now, an accommodative stance seems appropriate and, in our view, increased liquidity should prove a tailwind for equities.

For example, the European Central Bank (ECB) implemented a new facility—the three-year Long-Term Refinancing Operation (LTRO)—in December 2011 to help alleviate potential liquidity strains. The ECB offered unlimited three-year liquidity to any bank in need at a low 1% interest rate and with über-lax collateral requirements. This had the added benefit of providing a rather enticing carry trade opportunity: Commercial banks can now park assets in Frankfurt (clearing room on their balance sheets), borrow cheaply and use the new funds to purchase higher-yielding assets. Many appear to have purchased Spanish and Italian debt, helping lower yields and effectively accomplishing a sort of back-door quantitative easing. Though not a fix-all for the eurozone by any stretch, it does seem to have accomplished the ECB's goal thus far. Another LTRO round is on tap in early 2012.

That's but one instance of central banks' dedication to backstopping an occasionally strained eurozone banking system. Another occurred in September 2011, when European banks encountered a US dollar funding squeeze. Though supply remained ample, borrowing costs were rising, and some feared an interbank lending freeze was in the offing. To help stem that risk, the US Fed teamed with the ECB, Bank of England (BOE), Bank of Japan (BOJ) and Swiss National Bank to provide unlimited US dollar liquidity to any bank in need. That eased much of the chatter about a dollar panic—higher open-market costs are less of a concern when central banks provide a reasonable alternative.

There's ample additional evidence of central banks' accommodativeness. The BOE launched a fresh round of quantitative easing in October 2011, and monetary policymakers suggest more is coming this year now that inflation is easing. The Fed and BOJ expanded their balance sheets in 2011 as well, as shown in Exhibit 1. Increased central bank asset purchases means less clunky debt tying up commercial banks' balance sheets, giving them more flexibility to lend. In time, much of that excess liquidity likely finds its way to capital markets—a potential tailwind for stock prices.

Exhibit 1: Global Central Banks' Balance Sheets

Source: Thomson Reuters, as of 12/15/2011. Balance sheet growth indexed to 100.

Add in continued low target rates, and it's clear central bankers are mindful of lessons learned in the wake of Lehman Brothers and doing everything in their power to help keep credit markets from seizing. That's not to say all their policies are perfect or perfectly advisable—unintended consequences are certainly possible, as always, and inflation is a heightened risk down the road if liquidity measures aren't reined in as needed once credit markets find a firmer footing. But for now, the banks' actions signify their resolve to continue supporting capital markets as needed.

(This article constitutes the views, opinions, analyses and commentary of Fisher Investments as of February 2012 and should not be regarded as personal investment advice. No assurances are made Fisher Investments will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.)