Global monetary policy

Market volatility to rise as central banks tighten monetary policy, says asset manager Vanguard

The chances are high of bumpy adjustments in risky assets, unlike in 2017. This year has already led to higher valuations and lower volatility

PUBLISHED : Wednesday, 10 January, 2018, 10:19am
UPDATED : Wednesday, 10 January, 2018, 10:14pm

The US Federal Reserve is shifting towards tighter monetary policy, and other central banks including China’s are expected to follow suit this year, as inflation rises and the global economy grows more robust, according to Wang Qian, chief economist for Asia-Pacific at Vanguard.

Tightening labour markets, which generate higher wage growth and inflation, are likely to embolden central banks to act more aggressively, with the Fed now predicted to raise interest rates three times this year.

Those developments are likely to trigger more volatility in the financial markets too, with investors keeping a keen eye on the interest rate outlook, Wang said.

The chances are high of bumpy adjustments in risky assets, unlike in 2017. This year has already led to higher valuations and lower volatility, she said.

Vanguard is one of the world’s largest investment companies, with about US$4.5 trillion in assets under management.

“To be realistic, China has also been tightening [its policies]. It didn’t raise the benchmark rate but it is tightening with regards to its regulatory overhaul, and also through rapid rises in market interest rates,” Wang said.

She expects the People’s Bank of China (PBOC) to raise the reverse repurchase agreement rates –

the purchase of securities with the agreement to sell them at a higher price at a specific future date – at its open market operation, by 5 to 10 basis points after every future Fed rise.

The risk is that [Chinese] policymakers become overconfident of the resilience of the economy and underestimate the negative impact of tightening
Wang Qian, chief economist for Asia-Pacific at Vanguard

“But the risk is that policymakers become overconfident of the resilience of the economy and underestimate the negative impact of tightening,” Wang added.

China’s inflation is expected to hover around 2.5 per cent this year. But if it hits the PBOC’s 3 per cent target, then it would increase the chance of a policy rates , Wang said.

Reforms of state-owned enterprises (SEOs), meanwhile, require structural changes to corporate governance and incentive mechanisms to improve efficiency and profitability.

Otherwise, simply going through short-term pain via industry consolidation, mergers and debt-to-equity swap programmes, that make SOEs become bigger and more dominant, will not necessarily lead to higher future productivity.

Similarly, China’s mixed-ownership programme means new private shareholders are likely to insist they have a place on the board, or at least a strong influence on the management of the new company.

The government is currently not allowing zombie companies to default or go bankrupt to avoid any shocks to the economy near term, even if getting rid of zombie companies and creating new, private companies in key industries would inevitably lead to the higher productivity during further the tracks.

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