Posts tagged ‘monetary policy’

Alternative Ending

Counterfactual writing has been popular for many years. What if the Nazis had won the war in Europe? What if there had been no Reformation? Extending the genre to finance one might ask, what if the bond market had closed to Italy in 2011? (More of a niche market there, perhaps, but an interesting question nonetheless . . . )

Investment decision making by contrast concerns the future, of course, whose range of outcomes is practically limitless. Where the FTSE 100 index will close the year is a matter of opinion. A successful investor could be defined as someone who gets those sorts of things right more often than she gets them wrong. The only certainty she has, however, is that the future could hold almost anything.

And so to inflation, the UK, and what happens next.

The data out last week showing another uptick in the rate of price increases in Britain will have come as no surprise to readers of this blog. CPI is catching up with PPI output prices which have continued to catch up with PPI input prices, which have continued to come in at around 20% higher than the same time twelve months previously. Notably, “RPIX” – the rate of retail price inflation excluding the impact of mortgage interest payments and the rate once targeted by the Bank of England – came in at +3.5% year-on-year (to February). A full point above the old target, that would once have provoked a letter from the Governor to the Chancellor. CPI has only just got up to +2.3%, however, so under the new regime there is officially nothing to worry about.

Yet.

Bearing in mind the enormous range of possibilities encompassed by the future we ought to be surprised at the strength of the consensus about what happens next. The Bank, the City, the leading independent forecasters: all are agreed that rising inflation will eat into wage packets, dampen growth, soften the labour market a little then fall away again. This time we all know how the story will end.

Taking this as read, then, let us try to be counterfactual, if only for entertainment’s sake.

On February data, real wage growth either flatlined (using CPI) or fell by 1% (using headline RPI). Let us follow the consensus in assuming that inflation grows by another point or so into the end of this year. That would push real wage growth down to between -1% and -2%.

Now: what if the effect of this was not only, or primarily, to impact growth? What if the expectation that wage growth will muddle along at a steady +2% is wrong? What if earnings actually start to rise to compensate for higher prices?

Like any good counterfactual tale our story needs to have its roots in genuine history to come across as believable to its readers.

In this case we might look at the distance travelled by the UK economy since the unemployment rate peaked in November 2011 at 8.5%. At that time average earnings growth was coming in at +1.7-1.8%, just a little lower than its present rate, though at the time this was a noteworthy trough and a level not seen since 1967. Wage growth subsequently fell further, hitting lows of +0.7-0.8% during the 2013-14 period. During those two years, however, employment growth had taken off in earnest with joblessness falling from 7.8% to 5.7%. Average earnings growth subsequently rose too, hitting +2.8% by mid-2015.

That British pay packets began to grow as spare workers became that bit harder to get hold of might well have been a complete coincidence. Indeed if we are to believe that earnings growth will not continue to accelerate today, as unemployment is down even further at 4.7%, equalling its post-1975 low, then that must be taken as read. The consensus, after all, is convinced of it.

Let us persist with our radical, counterfactual account, however. Suppose that labour market strength might genuinely correlate with wage growth. Where might that take us?

Prior to the Great Recession the average rate of earnings growth in the UK was +4%. Using a five-year lag from earlier peaks in unemployment wage growth reached +4.9% (February 1998) and +9.3% (May 1989). The economic, market and demographic environments were very different in their own ways at each of those different times, so the absolute numbers are not perhaps that illustrative. What they have in common is that they occurred during uptrends in wage growth established in the wake of falling unemployment.

For our fictional account of the British economy, then, let us assume that 2017 were to end with average earnings growing at 3-4%. With CPI and RPI inflation settling in the same range this would not represent boom times for wage packets in real terms. But it would not mean a growth-threatening contraction either. Expectations for increased labour market slack would surely go out of the window. Inflation projections would rise. Interest rate expectations would change. We might be entering 2018 worried not so much about contraction as about an overheating economy and a monetary policy that looked to have long since fallen behind the curve.

This is hardly a gripping, mass-market narrative. But it is the kind of thing that investors might want to weigh up in their thinking from time to time.

At least it would be if it were not the most absurd counterfactual, of course. Luckily the consensus is universally settled. We all know what is going to happen. In Britain’s immediate future, there is no alternative ending.

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31/03/2017 at 3:55 pm

Taking A Hike

Well that clinches it, surely. Today’s US data showed the unemployment rate down again to 4.9%. Payroll growth continued at a strong pace, with non-farm jobs up by 161,000 last month. Both these prints came out in line with expectations – but wage growth beat every estimate going, hitting a new post-recession high of +2.8% on the year. Purchasing manager surveys out over the last couple of months suggest that the rate of job creation will accelerate into the end of this year if anything. The American labour market is showing clear signs of warmth. Surely, a Fed hike next month is certain.

This chimes with the consensus view. Of the 66 forecasts currently made available to Bloomberg, 15 expect no change and all the rest are for a 25bp hike. The interest rate markets also expect the Fed to see out 2016 with a target rate of 0.75%, then go on to hike again around the middle of next year.

So far, so uncontentious. Indeed it is reassuring from an investor’s perspective that the market reaction to somewhat firmer expectations for interest rates has, thus far, been sanguine. Halfway through this year a December hike had yet to be priced in; by the autumn the eurodollar futures market had become unequivocal on the subject – Treasuries sold off too – but the S&P 500 still rallied, turning in its strongest quarterly performance of the year so far.

The key word there is: “somewhat”. In the US as in Britain there is now a real risk that tightening occurs more quickly than people think.

That +2.8% wage growth is part of the reason why. A connected reason is that the energy sector has recovered some of its strength this year, taking away a recent source of downward pressure on activity and employment. Then there are import prices: stable oil and a stable dollar have now closed off that source of deflation. Core CPI has already been running at its strongest sustained level this year since the Great Recession. Both the headline CPI measure and the consumption deflator used to calculate chain-weighted GDP have been catching up. Finally, unreliable indicator as it is and completely unfashionable as it has become, broad (M2) money supply growth is running at its fastest pace for nearly four years.

The question to which nobody knows the answer is: will the labour market start really overheating and, in the circumstances, contribute to an uncomfortable level of inflation? At the moment, US policymakers are split on the subject, but the Fed’s actual monetary response to date, together with the interest rate markets’ pricing, implies a near-total lack of concern.

Another wild card is our old friend political risk. At present, polling at the national level and in some of America’s “battleground states” suggests that Secretary Clinton is on course for a narrow victory. If Mr Trump were to pull off a surprise win, however, it is not just the market response but the economic consequences which could be significant. There has already been extensive coverage of the effect that the candidates’ fiscal policies might have on the national debt, but consider some of the Republican candidate’s other measures: the expulsion of migrant labour, swingeing tariffs on imports, less accommodative trade agreements (as well as big tax cuts for businesses and households). All of these would be inflationary.

It would be imprudent to expect a crisis. But the possibility of a problem is clear and what matters to us as investors is that this is not recognised – indeed, quite the reverse. Bond markets think that inflation over the next ten years will run at an average of 1.7%, below the 2.1% they have priced in on that horizon over the last 15 years. Consumer expectations for near term inflation, as measured by the University of Michigan survey, are below average too, and for long term price behaviour are at their lowest ever level.

So there could well be a surprise or two in store. And whatever its scale, this ought to have consequences for portfolio construction.

04/11/2016 at 4:32 pm

Great Expectations

A speech to the G20 summit in Shanghai from the Governor of the Bank of England has drawn some media interest today. Mark Carney’s words of caution to his fellow central bankers on the subject of negative interest rates centred on the “zero sum game” of seeking export-led recovery. He noted, quite rightly, that “beggar-thy-neighbour” policies at the country level would do nothing to address the sluggishness of global demand. And only on Tuesday he told the Treasury Select Committee that Britain’s policy rate would not go negative.

He did, however, say that it might be cut.

Sterling hit a new trade-weighted low on Wednesday and has now fallen by more than 10% from its August peak to a level last seen two years ago. Now the downward trend started back in November and has also received a helping hand from David Cameron’s successful reform of the European Union last Friday. But Governor Carney’s words, and those of his colleagues on the MPC this week, do undermine the credibility of his Chinese lecture at least a little.

This is especially the case since the pound’s impact on inflation has long been singled out in the Bank’s quarterly reports on the subject. A bout of moderate currency weakness could give a nice boost to CPI, if only on a forecast basis, bringing it closer to the target rate of 2% per annum without the MPC having to resort to any further loosening of policy over the coming months. And the side effect of a positive impact on British exports is just something the Bank would, regrettably of course, have to live with.

Look at the last Inflation Report and the underlying data, however, and even sterling is a side-show. As so often over the past 18 months the big news is oil.

This blog wrote about the impact of energy prices on the Bank’s assumptions for inflation back in November. Since then the effect has grown. Oil price assumptions for this year and next are down by 34% and 29% respectively; forecasts for gas prices down by 24% and 21%. On the MPC’s arithmetic this is in the process of translating into added deflationary pressure in 2016 of 0.4% p.a. by way of petrol prices and gas bills alone, with additional effects via the pass through of lower production costs (this being more difficult to time as well as to quantify).

It is, then, unsurprising that it has been oil, not sterling, which has exerted the more powerful pressure on interest rate expectations. These were already very benign, with UK rates only expected to rise late this year or some time into next. Look at futures markets today, however, and they are not pricing in any chance of policy tightening until the second half of 2018, with the base rate remaining under 1% until at least the end of the following year. As with the pound this change has been quite rapid. The 3-month LIBOR future for December 2019, which now prices at 1.02%, was priced at 2% on New Year’s Eve.

While the press looks to the pound, therefore, the rates market has been looking at the oil price.

And yet even the February Inflation Report is rightly cautious on this subject. It notes that the drag from lower energy prices will unwind over time, and that its CPI forecast on a three year view is broadly unchanged. Elsewhere it further notes that the labour market has strengthened more rapidly than expected back in the autumn: in fact it now forecasts UK unemployment of 4.8% both this year and next, revised down from 5.2% and 5.0% respectively. This is nothing less than a prediction of full employment, if the history of the last forty years is any guide. And at the same time the ratio of vacancies to the total labour force has risen again. This measure averaged 1.5x over the period 2010-12, when the UK labour market stagnated around an 8% level. Then it rose to 1.7x in 2013 and 2.0x in 2014, a time of rapid jobs growth which saw unemployment reduce to 5.7%. For 2015 the ratio hit 2.3x and unemployment already stood as low as 5.1% come December.

Under normal circumstances this would ignite at least an amber warning of cost pressures by way of wage increases. At present, however, this pressure is contained by the current low level of headline CPI, as the Bank also notes. (What the Bank doesn’t note but is nonetheless equally material is that low inflation has a direct impact on wage settlements in the public sector – about one in every six jobs in Britain – together with pensions and other welfare payments.)

The UK is close to full employment, the deflationary impact of a strong pound has fallen away in short order and price pressures are being contained only by the continued weakness of a commodity whose average annual price change in either direction over the last ten calendar years has been 30%. Interest rate markets are expecting this happy circumstance to persist for at least the next two to three years. From some perspectives – that of the property market, for instance – it would be lovely if they were right. But the more prudent thing to do, surely, is to think about what might happen if they are not.

Let us leave the last word to the Bank of England:

“At its meeting ending on 3 February, the MPC judged it appropriate to leave the stance of monetary policy unchanged . . . All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles.

This guidance is an expectation, not a promise. The actual path Bank Rate will follow over the next few years will depend on the economic circumstances.

26/02/2016 at 4:04 pm

The Year Ahead

As years draw to a close it is customary for market observers to make early Christmas presents of their thematic predictions. Here are this blog’s thoughts on some major considerations for 2016.

Starting with the obvious: monetary policy will enter what has become very unfamiliar territory for some economies, including those of Britain and the US. Expectations are that the Fed will tighten policy by 25bp next week; as we have seen, the Bank of England is not expected to follow until well into next year. But market expectations are for the gentlest upward path for rates in recent history on both sides of the Atlantic. Anything more than this will come as a major surprise.

On a connected point, oil made much of the market and macro running this year. The key futures were making new sub-$40 lows just this afternoon. But the key point is that the average price over the last 12 months is $55 as against around $100 for 2014. For cheap energy to mimic the disinflationary pattern established this year would require oil futures to trade down to $30 and settle there throughout 2016. That is a real possibility. On the other hand, a change in OPEC / Saudi Arabian policy on supply could see the price start to climb again. Even if it manages to hold its 2015 range of about $40-60, that will still be significant as the “base effects” of cheap energy on inflation will fade away. In other words the oil price is set to remain a key metric for the world next year – and is entirely unpredictable.

Talking of unpredictable, the election of the next American President is already making headlines almost a year before the event. It will inevitably hog the political limelight in 2016. But elections and electoral arithmetic in Europe are much more interesting from an investment perspective. In several countries, “right-wing populist” or far right parties are riding high in the polls and they tend to be Eurosceptic. We will see how the National Front fares in French regional elections this weekend but there are national elections brewing elsewhere. In Holland, where an election must be held by March 2017 and if history is any guide will take place earlier, the Party for Freedom is polling in the high thirties. In the meantime the Dutch will be voting in an “advisory referendum” come April on the EU’s dealings with Ukraine. There is room for some mild upset on that front and transformational political change at the European level from Holland come the general election. During 2016 the British referendum on EU membership will also be drawing nearer.

Major equity markets showed degrees of volatility this year not witnessed since the crash and panic of 2011. Several currencies had a turbulent time of things too. With the other themes in mind it appears likely that volatility will again feature in 2016.

This list is not exhaustive but will provide us with plenty to chew on over the coming months. In the immortal words of Louis Pasteur: chance favours the prepared mind!

11/12/2015 at 5:40 pm

Reading The Runes

Yesterday, just before lunch, some information was released by the Bank of England about the timing of the UK’s first rate hike. As a result, the pound posted its biggest one day fall against the dollar since August’s ghoulish gurgitations, the FTSE 100 reversed its morning losses and gilt yields fell across the curve. We know that markets are hanging on to every scripted syllable out of central banks these days – and the Old Lady had clearly delivered some big, big news.

Rather unfortunately it was not clear from the coverage exactly what this was. The headlines were all over the place. “Bank of England signals rates can remain at lows until 2017”, declared the FT, echoed by the equally authoritative voices of The Economist“The Bank of England may not raise interest rates until 2017” – and the Daily Express (“Interest rates may not rise until 2017, hints Bank of England”). On the other hand the Daily Telegraph asserted that “Global growth risks likely to keep rates at record low well into 2016, BoE suggests”, a more hawkish position putting it in the same corner as The Guardian (“Bank of England to leave interest rates at 0.5% until well into next year”).

So what had happened? Had the Bank signalled, hinted or suggested? And was the substance of whichever denotation that it would hike next year, or the year after? A year is a long time in these uncertain markets, and it would be useful to know.

The headlines were inspired of course by the release of the unmissable quarterly that is the Bank of England’s Inflation Report. But what could explain such varied interpretations of exactly the same material?

Look below the headlines and there were suggestions, or perhaps signals of the answer. The Economist piece, characteristically, brimmed with patriotic vigour, noting that Britain’s economy was now so pathetically weak that it couldn’t even produce the laughably stunted amount of inflation necessary to warrant a single miserable rate rise. The FT referred to the forecast path of inflation. The Express covered the bases on both domestic growth and inflation, while noting the impact of weaker growth abroad in passing. Both the more hawkish papers touched on this ground too, but interestingly also gave space to the impact of low commodity prices and a seemingly contrarian view that the domestic UK economy remained resilient.

This blog does its own homework and usually reads the salient parts of the Bank’s Inflation Report, together with the accompanying and much shorter but (if anything) more instructive Conditioning assumptions, MPC key judgements, and indicative projections data. And it is obvious from the latter that future assumptions about energy prices are much lower now than they were back in the summer – understandably so: as the small print tells us, they are based on futures prices and these have fallen. The Bank’s new prices for gas and oil in 2016 are respectively lower by nine and ten percent. As the s.p. further helpfully explains, these numbers “are used as conditioning assumptions for the MPC’s projections for CPI inflation, GDP growth and the unemployment rate.”

Given that these energy price effects will prove more or less transitory – even assuming they do not reverse over the Bank’s two-year forecast horizon – it is perhaps foolish to read too much into them. It is certainly a mistake to confuse them with weakness in the domestic economy. As Governor Carney himself noted in an afternoon interview with Bloomberg Television:

“My personal view is it is important that we look at [core CPI] particularly because of this imported disinflation, it shows up through core inflation,” he said. “What we want to avoid is to have cost pressures build up too much domestically to the extent that once these foreign factors ultimately pass through the economy, we’re overshooting that inflation target because of domestic strength.”

And the headline of this piece? “Mark Carney: Prudent to Expect U.K. Rate Rise in 2016”.

06/11/2015 at 11:33 am

Kicking The Can

The big news this week, of course, was the Fed. Rarely has inaction been so exciting! The statement put out by its Board of Governors is quite pithy as these things go and worth a read in full, and the salient policy points are all sandwiched within a single paragraph as follows:

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account … labor market conditions … inflation pressures and … expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

US unemployment for August was 5.1%, down half a point from the beginning of the year and nearer the bottom than the top of the Fed’s own range for the “longer-run normal rate of unemployment” of 4.7-5.8%. There is nothing here to justify emergency monetary conditions whatsoever. Despite the statement, therefore, the US labour market was in practice irrelevant to the decision taken by its central bank.

On inflation, the Fed notes elsewhere the “transitory effects of declines in energy and import prices”, and is absolutely right to do so. Fortunately it also has access, just like the rest of us, to “core” measures of both consumer and producer price inflation which specifically exclude food and energy. Headline CPI has crashed down from 2.1% in the spring of last year to 0.2% today, but the core measure has risen this year from 1.6% to 1.8%, not meaningfully distant from the stated target of 2%. Again, this is not consistent with an emergency monetary stance.

Having abandoned at least one and a half of the two elements of its mandate, then, the Fed has effectively announced it is acting with reference primarily or solely to an unofficial third: “financial and international developments”.

In one sense this is a masterstroke. Attributing loose policy to sources other than the domestic economy eliminates the risk of a bearish response to a downbeat assessment of the situation at home. (The Fed has come a cropper here before.) When a central bank produces an economic assessment that is news. When it points to events offshore that everyone has already seen, it says nothing new.

From another angle, however, yesterday’s decision does not look quite so masterly. Invoking the stock market as a reason for cheap money used to be known as the Greenspan Put, a source of moral hazard under the eponymous Fed chairman which attracted some of the blame for the financial crisis. And at least efforts were made to justify Mr Greenspan’s option writing in terms of a “wealth effect” on US household spending. Extending the put to the stock market in China seems startlingly multilateral even for these enlightened times.

Furthermore, all the Fed has done is postpone a move which would have taken nobody by surprise if they had done it this week. It is still perhaps a little early to gauge the market reaction but stocks are down in both the US and Europe today. The dollar has weakened just a touch against the euro, is pretty much unchanged against sterling and the yen and the Chinese yuan has not budged, so there is as yet no consoling impact for American exporters and multinationals. All that is certain is that the postponement has prolonged a key source of uncertainty.

The impact of a 25bp rate hike would have had a negligible impact on everything apart from sentiment. And it is far from clear that its market impact would have been any worse than that of the Fed’s eventual, barely defensible decision to dither.

So much for the new mandate to shore up financial and international developments.

Kudos, in conclusion, to Jeff Lacker, President of the Federal Reserve Bank of Richmond, the only one of the Fed’s twelve decision-makers to vote for a hike yesterday. His colleagues have in reality opted for nothing more cogent than mañana.

18/09/2015 at 3:43 pm

Sins Of The Policymakers

This morning’s leading headline on Bloomberg News read as follows: “Stocks Advance in Europe, Asia Amid China Holiday … ”

Without the peril of the Chinese stock market to contend with, European bourses were up by 1-2% early in the day and are higher at the time of writing. This certainly fits the narrative of those who see the collapse of the supposed equity bubble in China as the source of all the summer’s ills.

(Before moving on, a brief comment on that “supposed”. The Shanghai Composite Index rose by 58% from the start of this year to its peak on 12 June, having risen by 53% in 2014. It hit a p/e of 23.5x in the process – then began to fall. By the bottom on 26 August the drop had reached 43%. If that isn’t a bubble … ?

On the other hand that p/e was well below the 45.5x reached at the market peak of 2007 – a peak which has yet to be exceeded. And it is miles short of the 60-70x levels seen during the twilight of the go-go 1990s tech boom, and below the average level so far this century. In addition, +53% is only the fourth-highest calendar year price return for the index in the last ten years, the highest having been seen in 2006 when the market much more than doubled. Finally, the market was valued at under 10x earnings for long stretches of 2013-14 before the rally began, well below the 14x and 12x reached at the market bottoms in 2005 and 2008.

This is a febrile market which has undergone rapid change but to interpret its rally from the depressed point of mid-2014 as an egregious bubble episode is to make a glaring analytical mistake.)

Some of the actions of the Chinese government have been woefully unhelpful. Direct interventions in the stock market have exacerbated falls and sharpened investor concerns, as tends to be the way of these things. At the same time, special interests in the corporate sector have sought to manipulate the government’s response to their advantage.

Other parts of the world were in exactly the same place very recently. The SEC banned short selling of financial stocks on Wall Street from Friday 19 September 2008 – the week of the Lehmans bankruptcy – in an effort to “protect the integrity and quality of the securities market and strengthen investor confidence.” By the time the ban ended after the close on Wednesday 8 October the S&P 500 Diversified Banks index had fallen by another 22%. Christopher Cox, then Chairman of the SEC, gave an interview to Reuters after Christmas that year which contained the following little nugget:

Cox said the chief executive of one major U.S. investment bank even urged suspension of normal trading rules across the entire U.S. market, likening the situation to how Abraham Lincoln suspended habeas corpus during the Civil War and Franklin Roosevelt sent Japanese-Americans to internment camps during World War Two.

The chief executive said, “that is how America made it through such crises, and we couldn’t be too focused on maintaining the rule of law,” Cox said.

Now that is panic. When it hits markets it is perhaps understandable that policymakers are not immune.

At the same time as the SEC was floundering around trying to put the clock back, however, the US Treasury began to implement measures under the newly-enacted Troubled Asset Relief Program, including the purchase of mortgage-backed securities to assist in the repair of bank balance sheets. On 8 October 2008 the Fed cut its target rate for the first time since April of that year from 2% to 1.5% in a concerted move with the ECB, Bank of England and the central banks of Canada, Sweden and Switzerland. A month later it began its first tranche of bond purchases under QE.

The speed of the banking sector recovery in the US – as opposed to Europe or the UK – has been one of the great relative strengths of the American economy. While some actions of the American government were woefully unhelpful, therefore, others were more constructive.

Exactly the same is true of the situation in China today.

As this blog remarked over the summer, it had been ignored amid all the attention on stock markets that China’s exporters were being hobbled by the quite sudden strength of her currency against the euro (and, for that matter, the yen). Only a few days after that post was published the People’s Bank of China devalued the yuan by 1.9%, its most significant depreciation since the epoch-making 50% shift engineered in January 1994. By the end of the week the yuan was down all of 2.9% at 6.39 and has stayed close to that level ever since. A few days later the 12-month benchmark lending rate was cut, for the fourth time this year, and a further reduction in the required deposit reserve ratio announced for major banks. At this point the PBOC had fired all three monetary weapons in its arsenal in a single month.

Back in the 1990s China came to dominate production in certain low-technology sectors, such as toy manufacture, and remained a relatively small economy (still smaller than Italy by the end of the century). Through continued competitiveness, investment, innovation, and broadening into higher-tech areas such as computers and mobile phones, Chinese exports overtook those of the US in 2007 and of Germany two years later. Today China is the world’s largest exporter by a mile, with the annual pace running at $2.4trn versus $1.6trn for the US; fifteen years ago China exported about a quarter as much as the US did.

So exports matter to the Chinese economy, devaluation ought to help exporters, and monetary softening elsewhere ought to ease some of the pain in the property market and contribute to lending growth. All this is fundamentally supportive. Nonetheless, the devaluation in particular – arguably the least contentious policy response of all – was interpreted as a sign of panic and the stock market continued to fall. In other words the actual direction of monetary policy was ignored in favour of the presumed context for its loosening. This was obviously a bearish response which again has clear recent parallels elsewhere.

What must surely be only a little less obvious are the implications of this response for imminent policy action in other places. Mr Carney at the Bank of England has just dismissed the idea that the kerfuffle within and over China will throw the MPC off their envisaged tightening path for rates. In the US, speculation over the timing of the first hike in the fed funds target since June 2006 has reached fever pitch. Will it motor up to 0.5% in two weeks’ time, as the majority of forecasters currently expect? Or will there be a delay?

Most importantly for investors: would a September hike be taken as evidence of a strong recovery, or would it ignite fears that the Fed is taking away the punchbowl too soon? And would delaying until next month be seen as a welcome reprieve, or betray a conviction that the US economy’s expansion is weaker than was thought?

The consensus from market participants still seems to be that monetary tightening will be accompanied by the upward march of equity benchmarks because (a) tighter money is a sign of economic strength and (b) that’s what happened last time. But as the events of recent weeks have shown, markets can get nervous again very quickly. And the Chinese experience is a reminder that in those circumstances, even positive policy decisions are taken as a sign of something bad.

It is difficult – even, perhaps, irrational – to dislike stocks more today than before they tumbled. There does not appear to be a new recession suddenly lurking around the corner. But complacency over the ability of today’s stock markets to take higher rates in their stride sits uneasily with the reaction to China’s very modest devaluation and other policy manoeuvres.

 

03/09/2015 at 3:43 pm

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