The Lowdown on Markets to 11th March 2016
World Markets at a Glance
In this week’s issue
- The European Central Bank unleashes a much bigger-than-expected fiscal package.
- As a result there is more QE, further interest rate cut, and incentives for bank lending.
- “NIRP” and “ZIRP” plus negative bond yields are becoming the new normal.
- The Bank of England prepares to defend the UK financial system in the case of “BREXIT”.
- Commodity prices spike up with iron ore recording its biggest one day rise on recorded.
- Global equity markets continue to trend higher as calmer conditions prevail.
“The European Central Bank cuts rates and boost quantitative easing”
Global equity markets experience a mixed week but overall they responded positively to the actions taken by the ECB on Thursday. In effect, the president of the European Central Bank, Mario Draghi unleashed a bigger-than-expected package of measures in an effort to re-stimulate the eurozone economy. These measures came in the form of an expanded quantitative easing programme, some incentives to banks to increase their lending and further interest rate cuts.
As a result of this, the ECB have raised the amount of bonds that the Eurozone’s central bankers buy each month from €60 billion to €80 billion, which in turn, was a much larger expansion programme than some analysts were predicting. Furthermore, Mr Draghi also declared that they would expand their range of asset purchases to include high quality corporate bonds. Also he would make available to the banks further liquidity through targeted longer-term refinancing operations [TLRO’s] at rates as low as minus 0.4 per cent, effectively, paying them to borrow money.
“The ECB are now focusing more upon the eurozone economy”
And last but not least, the ECB has cut its deposit rate by 10 basis points to minus 0.4 per cent, this effectively, eases the impact on the banks with cheaper short-term loans and longer-term liquidity at negative interest rates, therefore, for all intents and purposes trying to motivate eurozone lenders to increase credit to households and companies. Clearly, these latest actions mean that the ECB are now focusing more upon the eurozone economy, less so on weakening the euro, but making a clear statement that interest rates will stay lower for an extended period.
“Mr Draghi did add his voice too many of the other world’s leading central bankers saying that he did not anticipate pushing European interest rates deeper into negative territory”
However, Mr Draghi did add his voice too many of the other world’s leading central bankers saying that he did not anticipate pushing European interest rates deeper into negative territory, given the impact that this might have on the banks. Indeed, crazy as it sounds “negative interest rate protocol” has been gaining some traction in recent times with the likes of Japan, Sweden and Switzerland all taking this path of action in recent times.
Other countries such as Denmark are using this strategy to protect its peg to the euro, whilst very recently even the US Federal Reserve Bank chair, Janet Yellen, has said that a change in economic circumstances could put negative interest rates on the table. Likewise, even the governor of the Bank of England, Mark Carney, has commented on “ZIRP” and “NIRP” in his recent interviews and statements to the press. However, it is very unlikely that the US or the UK will take these measures.
“Most banks are reluctant to pass on negative interest rates to their customers”
Indeed, perhaps even more staggering is the fact that over US$7.0 trillion worth of government bonds worldwide are offering investors yields below zero. That means that investors buying those bonds and holding them to maturity won’t get all of their money back. Likewise, whilst most banks are reluctant to pass on negative interest rates to their customers, in fear of losing them, a few have begun charging larger depositors.
Quite clearly, this might turn out to be a dangerous strategy as it is unlikely not to come without some consequences to the banking system. Indeed, we have already seen some asset bubbles form over recent years, such as the equity markets, whilst the currency markets have re-acted aggressively to central bank policies articulating a “race to the bottom” strategy. Equally, we have seen inflation rates remain willfully low in many of the western economies, whilst global economic growth has slowed, and in some parts of the world, has led to periods of recession.
“Riskier asset classes do have a habit of responding positively to central bankers”
Understandably, riskier asset classes do have a habit of responding positively to central bankers that intervene in times of panic and disorder, whether it is through pretences such as “whatever it takes” under “Draghinomics” or “Abenomics” under the “three arrows” strategy. Nevertheless, the reality is that after many years of central bank policy the global economy is still suffering, and is continually troubled with problems.
Admittedly, many of the central bankers remain steadfast and continually relay the message that there is still plenty of “tools in the tool box” they can use, but unfortunately, the longer the world needs to wait for the normalisation of interest rates, and inflation, the more despairing the markets and investors might eventually become over their present-day monetary policies.
“There is some good value in many European stocks”
Indeed, just looking at recent European corporate profits, you can see that they have delivered their worst earnings season since the financial crisis. This means that many of the individual European stock markets have fallen further behind the United Kingdom and the United States, which might be the reason why we have seen a pick-up in investor interest in UK and US equities. Regrettably, this does not bode well for the ECB, and European investors, if uncertainty were to persist, none-the-less, there is some good value in many European stocks, and therefore, investors should not be too negative in their assessment of the region.
Clearly, whilst European problems still remain very high on many analysts’ agenda’s, so does the question surrounding “BREXIT”. Certainty, the outcome is still too close to call and consequently the Bank of England is already preparing to defend the UK financial system against a possible run on the British banks, in the event of a “no” vote. Indeed, the Central bank has already announced that it would give the UK commercial banks three exceptional opportunities to borrow as much money as they would need before, and after, the poll on the 23rd June 2016. This should prevent any repeat of the financial crisis that happened in 2007 and 2008.
Understandably, this pre-announcement by the BofE will be met positively by pro-EU ministers given that it will hopefully prevent any destructive period. Also this means that there is very little, or no chance, of any UK interest rate hikes this side of the referendum, in fact, if the global economy were to weaken further then there is more likelihood of a rate cut, which in turn, would support the Bank of England’s recent comments regarding “zero interest rate protocol”.
“Have we reached the bottom in commodity prices?”
Another interesting event that has happened recently has been the spike up in commodity prices, particularly, that of iron ore which recorded its biggest one-day rise on record, copper, and the price of Brent crude oil which has jumped above US$40.0 a barrel for the first time this year. Obviously, this now poses the question “have we reached the bottom in commodity prices?”, perhaps, but we think caution should still prevail given that China is the largest importer of oil and metals and have promised to avoid a hard landing as they try to move away from manufacturing and infrastructure spending.
Over capacity is still an issue and re-balancing global demand over supply takes time when the world is awash with commodities, and of course, the recent aggressive rise in some prices has left many hedge funds short as they have bet against the likes of oil, meaning that they have had to reverse some of those positions rather rapidly. Nonetheless, commodities is certainly an asset class which is under owned by asset allocators, therefore, any further strengthening in commodity prices could encourage further interest from global investors.
“The price of gold bullion has risen aggressively”
Likewise, the price of gold bullion has risen aggressively with the precious metal up by 19 per cent reaching a 13 month high. This turnaround in sentiment for the yellow metal has seen it enjoy its best start to a year since 1980 as global investors have articulated their concerns over central bank policy around negative interest rate protocol. Certainly, in previous gold bullion rallies many global investors have voiced their opinions that gold yields nothing, but in this current backdrop zero, or indeed negative interest rates, the investment case for gold seems more appealing.
And so, with many bond fund managers now raising their cash positions on fears of liquidity issues, and central banks continually supporting loose monetary conditions, it is likely that the backdrop for financial markets will remain quite demanding with plenty of volatility in the making. However, this does open up opportunities for stock pickers given that there are occasions when both markets and selective stocks get oversold, therefore, patience could turn out to be quite rewarding over time.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s.
He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority .