Can central banks continue rescuing markets?

It's interesting to contemplate Friday's rally, coming as it did on the last trading day of January and after the Bank of Japan (BOJ) opened its monetary taps yet again, shifting interest rates into negative territory.

The momentum of that window- dressing push is unlikely to last, so the start of this week is likely to be more sedate. Beyond that the question is whether markets will continue responding to central bank support as they have from 2008-2014, or whether the effect of monetary injections will become increasingly short-lived. This question has significance since after the BOJ, there are expectations of more stimulus from the People's Bank of China (which could come at any time) and the European Central Bank (ECB) in March.

In this connection, Rabobank on Friday in a comment "Stuck in a money-go-round" discussed three scenarios in which loose money pushes up asset prices that then grow more disconnected with the fundamental backdrop:

1) fundamentals finally improve thereby justifying risky asset valuations thereby seeing this disconnect closed as bond yields rise;

2) fundamentals do not improve and, as a consequence, risky assets are sold and the disconnect is closed as equities are sold; or,

3) fundamentals do not improve but owing to the political difficulty in standing by and allowing equities to collapse we see more of the same 'bad medicine' in the form of yet more monetary policy stimulus''.

The bank quite correctly favours scenario 3) and concludes that in the absence of a new global growth engine, "policy stimulus will simply beget policy stimulus''.

The reference to "bad medicine'' above is of course, tied to the "bad economic news is good news for stocks'' method of investing, in which money is allocated according to where the stimulus is greatest, even if the economic benefits are questionable.

Some experts, however, believe that the flood of money really is helping to stimulate growth. One is Pictet Wealth Management's head of asset allocation Christophe Donay, who in a report last Tuesday said that the fundamentals suggest it would make sense at some point to start buying stocks again.

"Indeed, this point may be approaching. Outside of financial crises, the average length of a correction on equity markets is about 50 days - and taking the correction in December as the start of the current period of volatility, the length of this sell-off is now around the average," said Mr Donay.

"Since we do not believe that conditions point to a financial crisis, the magnitude and length of the sell-off suggest that we may well have reached the bottom, and are set for a rebound."

It's also worth noting that in Europe, bad news appears to be still good news - the January EU Commission survey on the eurozone on Thursday last week was even weaker than expected, with the headline economic sentiment barometer dipping sharply to 105.0 from a downwardly revised 106.7 in December.

Since this was lower than the consensus expectation of 106.4, financial research firm Ideaglobal said "this latest development will only serve to heighten expectations of a further injection of monetary stimulus from the ECB in March".

The US Federal Reserve, on the other hand, is clearly concerned with headwinds and global growth. It left interest rates unchanged last week which everyone expected, but spoke obliquely of its concerns. Observers have also noted the change in wording, from "solid" to "moderate", in describing growth and most now expect the Fed to only raise rates twice this year instead of four times previously.

However, if the efforts of other central banks don't yield economic benefits, will it then be forced to cut rates instead?


This article was first published on February 1 2016.
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