QE may have reached its limits, that is the stability it brought to the financial system may now have passed its inflexion point, overwhelmed by the relationship between portfolio focussed money and the supply of real returns: volatility may now dominate as asset prices become increasingly sensitive to real fundamentals. In other words the inherent leverage of QE risks negatively impacting asset prices, whereas before it provided support.
As such, I think we should not be surprised by the large fall in the Japanese market. A 7.32% fall in a QE inspired world market place after a heady run up in prices in all markets is not surprising. Increasing volatility though is a good indicator of the short term nature of marginal demand for securities in the market place.
With increasing QE, money is becoming increasingly portfolio focussed. Typically, an increase in portfolio focussed money supply growth should be proportionate to nominal I/C/P decisions within an economy – the value of a given unit of real return should not change all other things being equal. The wider the disparity between portfolio focussed money and economic growth, the greater the volatility of asset prices. We should expect option pricing risks to widen and asset prices becoming extremely sensitive to economic news.
The latest flash HSBC (compiled by Markit) China manufacturing PMI should therefore be a concern. China is a bell weather for global economic health and weakness in its manufacturing sector raises concerns over global demand and domestic Chinese growth. This is especially so given the increasing debt burden and the very heavy share of gross fixed capital investment in Chinese GDP. European flash PMIs also struggled.