Definitely not (yet) Taper Tantrum II

23 September 2016

Fears that the world’s central banks might take away the candy dissipated substantially this week. We take a look at both decisions from the Fed and the BoJ in more detail later in the weekly. Markets seem to have resumed the more sanguine track, having had another slight anxiety attack during the previous two weeks.

When the Fed’s announcement came out on Wednesday, many of the commentators pointed to the 7-3 split in the vote between the members with the minority voting for an immediate hike of 0.25%. The general tenor was that the clamour for a rate rise was growing.

The bond market’s reaction tells a different story. US yields fell again across the curve, the long end falling 12bps and outperforming the short end. Investors appear to take the view that the dovishness of the majority on the FOMC is increasing at least as much as the minority’s hawkishness, and that the Fed will remain easy and for longer than previously thought.

Perhaps the most important impact for risk assets is that policy shift is just not happening. Each central bank meeting brings the inevitable question “will they start tightening?” and each time the answer is no. Indeed, one could look at the BoJ’s targeting of the 10-year yield (at 0%) as implicitly saying that rates will remain near 0% for 10 years.

The message to investors; risk-free is return-free now and for the foreseeable future; carry only exists in riskier assets. “There is no alternative” – everyone will get squeezed into riskier assets so you’d better do it now.

To a large extent, I think we (in Tatton) have to agree with that view. The risk is not going to come from central banks responding to runaway growth and inflation. They’re winning the battle on that message. The danger will come if growth stalls and the much-talked-about fiscal response doesn’t happen in a swift enough fashion.

The big dip in risk assets happened in January and February. At that point, worries about a major stall in the global economy were very apparent and this fed through into a big liquidity squeeze. At that point, it was felt that the weakest spot was China and its financial system.

We’re definitely not in that particular place right now. China looks to be in a much healthier position economically, its financial system awash with money and with residential property prices going gang-busters again. Apartment prices, both new and old, are rising not just in the major cities but almost everywhere according to the data released this week.

The run-up in asset prices has coincided with improving economic data through the middle of this year, pretty much globally. The confidence that growth reflation is happening and is not likely be upset by central banks has been a very positive backdrop. Despite the talk about the growing likelihood of fiscal policy support, we haven’t really thought that it might be a pressing need anytime soon.

We’ve commented in previous weeks that there is much to be positive about in Europe. Its “run-rate” in nominal growth has been at least as strong as other developed economies with definitely no likelihood of central bank tightening given the slack in labour markets. However, we cannot shy away from its fragility given its institutions’ lack of policy consensus and consequent structural unresponsiveness.

Nor can we ignore the signs of financial system stress. Deutsche Bank may be a “one-off” but it does have the capacity to spark liquidity issues and the Bundesbank might be put in a very difficult position.

Absolute Strategy Research, our independent research provider, has indicated that they think equities may come under strain in the next few weeks unless economic data resume a strengthening path in fairly short order, especially in the Eurozone. We, too, will be watching closely.