Global Investment Environment of the Post‐Quantitative Easing World: The ‘new‐old’ and ‘new‐new’ Normal

Abstract

AbstractGlobal markets since late 2007 are not ‘normal’, where normal means market conditions we would expect to observe going forward in the absence of any new economic shocks. Financial markets have been dominated by extraordinary central bank policies that were created to deal with challenging market conditions reflecting heightened risk aversion and illiquidity. Markets in the future will have some characteristics that look more like the market conditions observed in the pre‐crisis period, which I call the ‘new‐old normal’ and other conditions that differ from the past, which I call the ‘new‐new normal’. I first review what happened during the financial crisis in terms of developments in three asset classes, equities, fixed income and currencies, to place the forward‐looking view in proper context. Then the transition period from the quantitative easing (QE) era of exceptional monetary policy to post‐QE markets is discussed. Post‐transition, we will see some features of the post‐QE world that will resemble pre‐crisis market conditions, the ‘new‐old normal’ with higher policy interest rates, wider cross‐country interest differentials, lower cross‐asset return correlations and a resurgence of the importance of cross‐country differences in fundamentals in international investing. However, some features of the post‐QE investment environment will be unlike anything observed in the past: the ‘new‐new normal’ with reduced liquidity and more days of exceptionally large volatility and asset price moves due to regulatory effects resulting in a reduced ability of market‐makers to provide inventory buffers for counterparties and electronic trading venues that shut down trading in high volatility periods; low inflation; flatter yield curves; and emerging markets providing less opportunity for diversification gains as they converge to developed financial market characteristics.