Looming Fed move triggers global reshuffle
When the world's central bank changes course, everyone else, it seems, has to follow. Expectations of more expensive money from the United States Federal Reserve are rearranging a range of asset classes as investors assess how much it is worth paying for future earnings or income streams.
A reversal in a multi-year downward trend in US interest rates could come as early as next month, according to some commentators. In light of Friday's unexpectedly strong job-creation data, a near-term tightening of rates seems inevitable. Caught on the hop, investors yesterday dwelt on the worst fears and hit the 'sell' button, leaving regional markets to register their biggest falls this year.
Rather than waiting for Fed chairman Alan Greenspan to spell it out, money managers need to reconfigure portfolios now for more troublesome terrain ahead.
Aside from lightening up on bonds - rising yields mean lower prices - renewed risk aversion is the dominant theme. The safety conscious will steer clear of lower-grade junk bonds and some emerging markets. Harder to quantify is the shake-out in the global financial system as 'dollar carry' trades are unwound. Such higher-risk trades, often favoured by hedge funds - borrowing a depreciating US dollar and investing in higher-yielding overseas assets - could reverse quickly and add to volatility.
Few markets can ignore a reverse gear in US monetary policy, particularly Hong Kong with its currency peg. Here, even the slightest change of pressure on the accelerator can transmit an exaggerated move in a stock market heavily laden with interest-rate sensitive property and banking stocks.
Yet, arguably, that description does not accurately reflect the make-up of an equity market housing a range of mainland corporations, as the fuel they run on is priced by the People's Bank of China, not Mr Greenspan.
What has changed, however, is the price the market now wants to pay for these earnings. And that price, which directs international fund flows, is still set by Mr Greenspan. Rate rises, especially near the beginning of an upward cycle, reduce the present value of forward earnings on stocks. Yields on stocks also look less attractive next to risk-free earnings garnered on higher-paying deposit accounts.
For instance, if earnings alone mattered, last month's 288,000 rise in US jobs would have surely seemed positive. In fact, Merrill Lynch in its recent Global Weekly report notes that paradoxically, 'growth tends to accelerate during Fed tightening cycles' due to the lag in policy having an impact.
Ultimately, higher interest rates will cause a greater financial burden for debt-heavy companies, but near-term price rather than earnings is the yardstick to watch.
Once the market has had time to digest the new interest-rate reality, the next move will be to have another look at earnings.
No doubt some of China's corporates are likely to still prosper but, for now, all earnings will look a little less attractive. With no move from the Fed expected at least until next month, once again May might be a good time to take a break from the equity markets.
