Why central banks will retain their decisive grip over markets
While Trump’s victory raised hopes that the economic stimulus baton is finally switching hands from central banks to governments, a ‘presidential put’ is wishful thinking
Which is more important in determining sentiment in financial markets: the actions of central banks or those of politicians?
Prior to the shock victory of Donald Trump in last November’s US presidential election, the answer was all too obvious.
As recently as September, Claudio Boro, the head of the monetary and economic department of the Bank for International Settlements (BIS), the central bankers’ bank, warned of the over-reliance of markets on the ultra-loose monetary policies of central banks, noting the “sensitivity [of investors] to central bankers’ every decision and utterance” and the risk that “central banks have been overburdened for far too long.”
Borio said it was essential that “a more balanced policy mix” emerge in which governments play a stronger role in fostering growth in the global economy.
Fast forward six months and it appears that the BIS’s concerns have been somewhat assuaged.
In its latest quarterly review published last week, the BIS noted that “politics tightened its grip on financial markets in the past quarter”, resulting in a breakdown in correlations between asset classes and a reduction in so-called “risk-on/risk-off” behaviour which has stemmed largely from investor perceptions of the conduct of monetary policy. According to Borio, “the markets’ close dependence on central banks’ utterances and actions was at least temporarily weakened during the [past] quarter.”
Trump’s victory accounts for most, if not all, of the sudden shift in the determinants of investor sentiment.
The heightened expectations that the former property tycoon will pursue pro-growth policies, including tax reform and infrastructure spending, have prompted talk of a macroeconomic regime change in which fiscal policy begins to oust monetary policy as the key driver of markets. Jonathan Ferro, an anchor at Bloomberg TV, has even talked of a “presidential put” which could supplant the much-talked-about “central bank put” - the assumption on the part of investors that central banks will be willing to loosen policy during periods of financial turmoil in order to support asset prices - that has been in place since the global financial crisis.
Since Trump’s victory, global stock markets, as measured by the MSCI All-Country World Index, have shot up 8.3 per cent and currently stand just below their record high set on March 1. In a note published last month, BlueBay Asset Management noted that volatility levels in the benchmark S&P 500 equity market have been declining just as global economic policy uncertainty is increasing.
The “presidential put”, it seems, is working, at least for the time being.
Yet the influence of politics on market sentiment is more unstable and unpredictable than the policies of central banks.
For starters, investors are already beginning to worry that Trump may struggle to win Congressional approval for his economic policies, resulting in a less comprehensive programme which could face significant delays.
In the euro zone, fears that Marine Le Pen, the leader of France’s far-right National Front party, may win the second round of the country’s presidential election on May 7 have contributed to a 45 basis point rise in the yield on France’s 10-year bonds to 1.1 per cent. JPMorgan warns that France’s 2-year yield could surge to 10 per cent if Le Pen wins the election and manages to secure approval for her plan to take France out of the euro zone.
In the UK, meanwhile, premier Theresa May is seeking to invoke Article 50 - the formal mechanism for leaving the European Union – as soon as this week, plunging Britain into a protracted period of tense negotiations with the remaining 27 EU members which could put further pressure on the pound.
Make no mistake, political uncertainty means that central banks are likely to retain a strong, indeed decisive, grip over markets for the foreseeable future.
Nowhere is this more apparent than in the mounting speculation that the Federal Reserve – which is widely expected to raise interest rates on Wednesday – may have fallen behind the curve. A sharper repricing of US monetary policy, which could happen if the Fed sounds a hawkish note this week, would shift the sentiment pendulum firmly back in the direction of central banks again.
In a book published last year, Mohamed El-Erian, the veteran bond investor and currently chief economic adviser to Allianz, described central banks as “the only game in town”.
Indeed, they still are.
While Trump’s victory has raised hopes that the economic stimulus baton is finally switching hands from central banks to governments, a “presidential put” is wishful thinking.
Nicholas Spiro is a partner at Lauressa Advisory