It is the trillion dollar question that is stalking markets across the world.
Can the global economy stand on its own two feet once the Federal Reserve, and other central banks, step back from extraordinary measures to boost growth?
“Economic growth has been strong almost across the board so far this year, but that is not an all-clear for loading up in risky assets,” said Steen Jakobsen, the chief economist at Saxo Bank in an interview with CNBC on Thursday.
The Middle East, the earthquake in Japan and the end of quantitative easing will increase volatility and bring more “two-way” action to markets than we have seen in the recent past, according to Jakobsen.
“The global recession of 2008/2009 forced central banks to be creative. As unemployment rates shot up, GDP fell and stock markets panicked, they dreamt up a whole alphabet soup of solutions,” he said.
“Quantitative easing was one such solution and in the case of the US it was even extended in late 2010, sparking a rally in equities and commodities, in particular,” said Jakobsen Inflation has been the consequence of this policy, raising the question: “Can risk stand on its own two legs when the punch bowl is removed?,” said Jakobsen.
It remains to be seen whether the Fed will actually remove the punch bowl, and Jakobsen says Chairman Ben Bernanke is waiting for any further sign of economic weakness to extend the second round of quantitative easing, known as QE2.
“The new Congress has done nothing to stop Bernanke’s experiments, and it seems as if the Fed is only waiting for renewed economic weakness to occur to have sufficient arguments in favor of further monetary easing,” Jakobsen said.
If the Fed does extend QE2, Jakobsen will reverse his bullish view on the dollar. He is not bullish on corporate earnings however as he is worried inflationary pressures will hit margins.
“Our warning of cyclical peaks in company margins has so far been premature, but pressure is building on input prices across the world and unless companies can pass them on to customers – thereby increasing CPI (consumer price inflation) and encouraging central banks to raise rates – earnings growth is expected to slow as we progress through the year,” he said.
The euro zone and China remain a cause for concern for Jakobsen.
“Our yearly outlook speculated that China and the euro zone both pose potential risks, and these problems have not been solved. Instead, Portugal is more or less in the bag as far as a bailout goes, giving bond vigilantes plenty of months to prepare for an attack on Spain,” he said.
“The People’s Bank of China is raising interest rates as consumer prices tick up by the day while the property market is slowing alongside new loans - not the optimal cocktail for 10 percent growth in our eyes. Buckle up, volatility is here to stay,” said Jakobsen