ince the Great Recession, the world’s major central banks have responded to every crisis in the equity and credit markets by easing monetary policy—often using extraordinary means—to calm the market’s jitters and prevent the spread of any contagion.
But recent developments suggest that the Federal Reserve, the Bank of Japan and the European Central Bank’s ability to combat faltering economic growth and instability in the credit market has diminished. If the market starts to question the steadying hand of monetary policy, global equity markets could struggle mightily.
Bank of America Merrill Lynch’s Global Financial Stress Index (GFSI) measures the strain in global equity, credit and interbank lending markets; index readings greater than 0.5 suggest extreme levels of stress.
The GFSI spiked to 0.85 earlier this month and continues to hover around 0.7—levels last witnessed when the EU sovereign-debt crisis experienced its annual summer flare-up in 2011, 2012 and 2013.
In each instance, the Federal Reserve sought to calm the market with additional quantitative easing and/or reiterating its commitment to keeping interest rates near zero for an extended period. The European Central Bank ultimately resolved the situation through a bond-buying program that helped to support fiscally troubled EU members.
The Bank of Japan also responded with an extraordinary wave of stimulus. In April 2013, Japan’s central bank started its quantitative-easing program, committing to purchase between JPY60 trillion and JPY70 trillion of government bonds and other assets each year. In October 2014, the Bank of Japan upsized this annual target to JPY80 trillion (US$700 billion), equivalent to about 15 percent of the national economy.