Whether we like it or not, markets have now entered a new regime.
Since 2012 markets had enjoyed one of the strongest bullish trends in history – until they started to roll over in the spring of 2015. The catalyst for this regime change was simple: markets had been fuelled by confidence in central banks’ ability to return world economies to their pre-crisis shape.
Hot on the heels of the US Federal Reserve quitting its own quantitative easing programme, last year brought the unwelcome news that despite central banks’ best efforts, global economic growth was tepid and fragile. Worse, with monetary policy still extraordinarily accommodative, there is next to no ammunition left for central banks to smooth out the next economic downturn when it comes.
The new regime means less supportive trends for asset prices as their main performance engines – growth and central bank support – are sputtering, with more instability since central banks don’t have the firepower to dampen volatility.
Passive funds have had their time of glory, while risk management was looked after by central banks. After five years of misery watching assets move to cheaper index trackers, active fund managers can now demonstrate that managing risks brings value.
But that’s easier said than done. Risk management can be a powerful marketing concept, but the proof of the pudding is in the eating. The inertia of markets and the vested interest of asset managers to promote an ever-bullish narrative can keep investors’ optimism – and therefore comfort with passive indices – unchanged.
| Monetary policy: US/Chinese central banks |
Alex Wolf, emerging market economist at Standard Life Investments, assesses how the diverging monetary policy paths of the Chinese and US central banks have affected capital flows in China: “Although many factors, including softer domestic growth and capital account liberalisation, have played a role in renminbi volatility, the largest factor in the currency’s weakness continues to be policy divergence between the People’s Bank of China (PBOC) and the US Federal Reserve. “The ongoing feedback loop between the Fed’s push for policy normalisation and the PBOC’s attempt to ease policy and maintain a stable exchange rate have been affecting financial markets and forcing both central banks to be more cognisant of each other’s policy intentions. As domestic interest rates have continued to fall in China, and expectations of Fed hikes continue to build, pressure has mounted on the renminbi. “The policy loop could be described as such: the renminbi moves weaker against the dollar, both because of weakening economic fundamentals but also capital flight. This deepens depreciation expectations, which sparks further capital flight. Capital outflows and reduced PBOC foreign exchange reserves spur global risk-off sentiment and increases US financial stress, which in turn impacts Fed policy. “This delicate balance has been playing out since the PBOC started cutting rates in 2014 and has forced an increase in co-operation between officials of both central banks, with reports suggesting that PBOC officials are directly asking Fed officials for the timing of the next interest rate hike.” |
