15th September 2017

Business skyscrapers abstract conceptual architecture

Central banks have had financial markets on notice for quite some time now regarding a tightening of monetary policy. As we have written in the past, the lack of volatility arising from this has been eye catching. It takes a lot to make the markets blink these days, not even geopolitical risk can do the trick anymore – witness the market’s recent ‘missile fatigue’ over North Korea’s continued aggression. As far as policy activity is concerned, history tells us that central banks all too often miss their cue to act, admittedly more often in relation to tightening than loosening monetary conditions. The current delaying of the Fed’s balance sheet unwind/rate normalisation would appear to be straight from the playbook of the Greenspan/Bernanke Fed. The ultimate goal being the creation of a wealth effect and the onset of a prolonged goldilocks economy. In our mind, there is a fundamental problem with this. The wealth effect should be a by-product (albeit an important one) of a proficiently functioning capital market, not an end in itself. The primary objective – the efficient allocation of capital.

Excessive interference in the natural market pricing mechanism may have distorted the picture for the Fed and others. As well as driving valuations to extreme levels, some have argued that the flatness of the yield curve in the US today is more to do with QE related asset flows than it is an expression of the growth outlook for the economy. Furthermore that it may even be influencing the Fed’s decision to hold off on tightening policy. No one can say for sure. One conviction we do hold however is that wage growth holds the key for future Fed policy. If we see a continuation of what has thus far been gradual wage inflation, we believe the Fed will act. If for no other reason than to preserve their credibility.

Away from central bank policy, recent pockets of volatility have emerged in certain segments of the UK credit and equity markets. Provident Financial, Dixons Carphone, Greene King, as well as retailers John Lewis and Next have all reported worrying declines in profit. It may be too early to ascertain whether this is symptomatic of a broader malaise (although surely Brexit cannot be helping) and can perhaps be explained by structural change in some instances (e.g Amazon vs the High St). Nonetheless it is a situation that requires monitoring. If nothing else it demonstrates that volatility is never far away, something which can of course create opportunities for discerning, active investment managers.

 

By Steven O’Hanlon

 

The views above are published solely for information purposed and are not to be construed as a solicitation or an offer to buy or sell any securities, or related financial instruments. It does not constitute a personal recommendation as defined by the Financial Conduct Authority (“FCA”) or take into account the particular investment objectives, financial situations or needs of individual investors. The views above are based on public information and sources considered reliable.