The smart money is doing something that can only be read one way
Global investors beating a retreat out of risk assets seems a rational course of action
Nobody imagined it would end up this way. When the world’s major banks opened up the magic box of zero interest rates and quantitative easing seven years ago, it seemingly offered an open invitation to investors to party-on, beat the global financial crisis and heal the world economy in the process. Pumped up on monetary steroids, now the hangover is setting in fast.
The plan – if there ever was any coherent strategy – is becoming badly derailed. There are widespread signs of investors de-risking and for good reasons too. Global growth has faltered, the war on deflation is not over, political risks are in abundance and the major central banks have lost their way. This week’s central bank meetings in the US, Japan and the UK should highlight that global policymaking is in paralysis.
The uncertainty is nowhere more evident than in falling equity markets, rising credit spreads and the latest sharp jump in market fear gauges like the VIX equity volatility index. There’s been a continuing investor flood into safe haven trades, with German government bond yields hitting new record lows and the sharp rise in the Japanese yen further proof that investors are seeking better protection and shelter in safer home waters.
Investor polls and flow of funds survey show a similar tide of flight to quality and a battening down of the hatches. Global investors have run down their equity weightings to the lowest levels since the height of the Greek debt crisis three years ago. US mutual funds have similarly downsized relative shares of global equities in overall portfolios. The shutters are coming down.
Global investors are clearly scaling back. So far there is no major hullaballoo, but there is clearly a quiet slide towards the risk asset exits. The trouble is there are few places left to run and hide and make any decent returns in the process. Traditional bolt holes for investor cash in troubled times, like Swiss francs and the front end of the German government bond curve are steeped in negative territory. The long end of the German curve above 10 years maturity is poised to join the US$10 trillion negative yield club.
Thanks to super-stimulus, exceptional easing and the glut of global funds generated by the central banks’ QE operations in the last seven years – over US$15 trillion at the latest count – available safe haven sanctuaries are being inundated. Investors seem happy to take negative returns in exchange for capital protection in these sheltered markets. Profit expectations are being dramatically scaled back.
In the very short term, Britain’s Brexit vote on June 23rd is doing its bit to throw a spanner in the works for investor confidence. The last minute surge in support for the exit camp is clearly adding to market jitters and raising concerns that a British vote to quit Europe could unleash a major new wave of anti-austerity and euro scepticism in the hard pressed euro zone nations. It is not just the usual suspects – Greece, Portugal and Spain – but even voters in France are expressing growing anger towards Brussels’ and the European Union.
If European unity and economic integration is in danger, then European markets are in trouble. No wonder then that European equity markets are taking a dive and investors are shifting out of peripheral European bond markets and heading into relatively safer German bunds. This could mark the start of a new de-convergence trend and major spread widening drift for the higher risk fixed income markets.
There is nothing the central banks can do to stop the rot, short of more super-stimulus and opening up the portals to excessive risk-taking and increased irrational exuberance. There is a limit to how far this can go. Even Germany’s central bank chief Jens Weidmann and Finance Minister Wolfgang Schaeuble are saying enough’s enough and warning that an extended period of low European interest rates could lead to an abrupt surge in risk premiums. Germany’s antipathy could block further European Central Bank easing.
Even the US Federal Reserve is stuck on its rate tightening intentions, especially now that the US economy is showing signs of losing momentum. It adds to the growing perception that global monetary policy is in paralysis.
If the major central banks are reaching the end of the line on what’s to be done then world financial markets are in trouble. With dark clouds gathering on the horizon, global investors beating a retreat out of risk assets seems a rational course of action.
David Brown is chief executive of New View Economics