Central banks around the world have been exceptionally supportive of the financial markets this year. Despite lacklustre profit growth, so-called “easy money” has been pushing global stock markets to new highs almost weekly while handing bond markets a banner year. As a concrete measure monetary accommodation, the US M2 measure of money outstanding, which includes cash, chequing, savings deposits, small certificates of deposit, and money-market funds has been growing at a rapid clip of just over 10 per cent over the past three months.
For better or worse, headline inflation across the spectrum of larger, developed economies remains relatively tame, US wages are growing at a respectable rate and the unemployment rate is constructively hovering near a 50-year low. However, with the marginally better incoming economic data, a bit less stimulus may be expected from the G3 going forward.
Indeed, Fed chairman Jerome Powell recently stated in a speech in Providence, Rhode Island: “At this point in the long expansion, I see the glass as much more than half full. With the right policies, we can fill it further, building on the gains so far and spreading the benefits more broadly to all Americans.”
Last week’s statement stands in contrast to what is now known as the “Powell Pivot”. Earlier this year the Fed pledged to be “patient” about further interest-rate hikes, thereby putting to rest a three-year process of monetary tightening which included nine interest-rate increases starting at the end of 2015. Since then, America’s central bank has reversed course and taken rates back down to levels last seen in March 2018.
Fed officials cut rates over this past summer by three quarters of a percentage point from July to October as global growth began to slide and worldwide manufacturing was negatively impacted by the ongoing trade wars and heightened political uncertainty across the globe.
Chairman Powell suggested the last round of cuts were designed to provide insurance against a more serious downturn.
The Fed is now in data-watch mode and may be contemplating a slightly more hawkish stance from this point forward. The Federal Funds futures market is pricing in almost no probability of another rate cut this year compared to a 57 per cent expected probability just two months ago.
On the other side of the Atlantic, the ECB is debating whether or not to inject further stimulus into the system despite anaemic growth and below-target inflation. A growing narrative may be that since “lower for longer” interest rates have not really helped Europe after all this time, now may be time for a different approach.
Political leaders in the region are currently contemplating new strategies such as enhanced fiscal policies such as increased government spending. Analysts at European-based Rabobank recently opined that “further rate cuts could become counterproductive, effectively serving to tighten financial conditions in the eurozone”.
While we may be near the beginning of the end of US and European rate cuts, other countries have recently climbed on board the low-rate train. In total, 16 central banks reduced interest rates in the third quarter of 2019. Historically, easy money has been followed by a pick-up in global manufacturing. So far, this has yet to be seen. However, we may be experiencing a delayed effect in part due to the trade wars.
A resolution on trade, and in particular the Sino-US conflict could give equity market a further boost into year end and on into 2020. However, this might come at the expense of rising yields out of the rate curve which would negatively impact prices on longer duration securities. On the other hand, a return to a more positively sloped yield curve should be helpful for the banking sector.
• Bryan Dooley, CFA is the senior portfolio manager and general manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority