Earlier this month, the Norwegian Arctic island of Sommaroy, which enjoys 69 consecutive days of 24-hour daylight between mid-May and late July, bid to become the first place in the world to officially banish time. The islanders’ demand to do “what we want, when we want” stands in strict contrast to the actions of their nation’s central bank, which has just raised interest rates to 1.25% on the back of a strong economy and resilient inflation. That action stands in stark contrast to much of the rest of the world, where, rather like the partying islanders of Sommaroy, the asset party remains very much in full swing.
Last week, we saw European Central Bank (ECB) President Mario Draghi turn ‘dovish’ once again, and the market reaction was broadly to buy anything and everything. The ECB remains very focused on the level of inflation: too low (especially if it is coupled with slowing growth and increasing political risk, which is exactly what we’ve seen so far in 2019) equals more stimulus.
Draghi’s speech in Portugal on June 17 established the ECB’s position: if the economic backdrop (especially inflation) stays weak, the ECB will again be on the monetary loosening path. But are things as bad as the ECB suggests? I would say no. Inflation is falling (currently at 1.2%), but putting this in context, while it is well below the ECB’s 2% inflation target, it is well above January 2015’s negative figure of –0.6% (when the ECB last announced quantitative-easing methods). Although manufacturing confidence is in contraction territory, overall business confidence, including services, is still showing the eurozone economy to be growing, albeit very slowly, so we would contend that the ECB (and the bond market) appears to be getting ahead of itself.
The ECB’s change of attitude has been replicated across the world, with some central banks having already cut rates. With growth still ok, this policy is supportive for all assets, so any economic/market weakening will be met once again with the opening of the liquidity taps, meaning that government bond yields should remain low and credit spreads should tighten. Low inflation and slowing growth is forcing central banks’ hands.
Loosening Priced In
The market is already pricing in significant central-bank loosening, and the US Federal Reserve has now joined in the fun, confirming that it will cut rates if economic data (especially inflation) continues to disappoint. What did the market do? It started to price in even more dovishness; there is now a 75% chance of three rate cuts in the US this year. What the market didn’t do was to price in an imminent recession, and, consequently, credit spreads are heading back to their 2017 lows, inflation expectations have risen, and emerging markets have rallied. The market is anticipating yet another liquidity-fueled party.
If central banks don’t follow through with their latest quantitative-easing promises, disappointment is likely to be reflected across all markets, because everyone is already at the liquidity party expecting free drinks.
While President Trump’s critical comments towards Draghi and US Federal Reserve Chairman Jay Powell might draw attention, we view his tweets as a source of short-term noise and volatility, as opposed to a guide to a longer-term direction of markets. To us, liquidity remains the key driver of markets, rather than the next tweet from the US president.
The key question now is how long will this party atmosphere continue? With the expectancy of further central-bank liquidity to drive asset prices and markets in the near term, former Citigroup chief executive and chairman Chuck Prince’s now infamous 2007 line, in which he told Wall Street to “get up and dance” while the music still played, seems to be ringing louder every day.
Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice.
This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.
Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.
Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2020 The Bank of New York Company, Inc. All rights reserved.
In Canada, Newton Investment Management Limited is availing itself of the International Adviser Exemption (IAE) in the following Provinces: Alberta, British Columbia, Ontario and Quebec and the foreign commodity trading advisor exemption in Ontario. The IAE is in compliance with National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations.