Lessons from history
One of the strangest market weeks in a fair few years is finally drawing to a close, but we must ask ourselves, if the sell-off in risky assets is over, just what damage has it done?
In the late 1990s, world markets took a hammering as Thailand, Korea, Russia and other emerging markets crashed courtesy of a strong dollar, over-leveraged financial sectors and an abundance of poor monetary policy decisions. The crash defined these markets and still does now but the wider impact was very little.
If you were to look at a chart of US, UK or German GDP in the late 90s you would hardly have known that the IMF was flying around emerging markets prescribing austerity and launching bailout packages.
Wall Street vs High St
The impact of ructions and volatility within financial markets obviously can have an impact on the ‘real’ economy; you only have to look back as far as 2008 to see that. We have to feel, however, that this week’s wobble; as terrifying as it may have looked whilst we were in the teeth of it is unlikely to draw too much pain from GDP, retail spending and unemployment.
Janet Yellen sat in front of the Senate yesterday and once again repeated the line that the Federal Reserve was watching financial markets closely and that weakness may cause delays to the Fed’s policy of normalisation. She would have been seen as irresponsible and blinkered had she of not. She did, once again however, remain optimistic about the macroeconomic performance of the US economy, its ability to create jobs and subsequently, bring inflationary pressures to bear.
Central bank expectations take a kicking
Yesterday we saw rate expectations completely collapse. We knew that some markets were pricing in no interest rate hikes in the UK until the end of 2019 but swaps markets were fully pricing in a 25bps cut by the Bank of England within the next 12 months and no rate hikes by the Federal Reserve until 2018.
I personally think that these moves are bewildering.
I am not a newfound hawk, nor am I predicting that the dollar is going to the moon. What I am saying is that this sell-off, led by European banking shares, is not a world ending move. I firmly believe that these market fears are entirely misplaced, specifically around bank debt levels and that once markets become wise to this fact then the need for a haven position, in debt, the euro or the yen will be traded away in favour of yield hunger.
The Day Ahead
As for this morning we have a rather cautious open with Asian shares lower although European markets have opened in the green. The data calendar is quiet today; data regardless of stripe or colour has had little impact on these markets but Eurozone industrial production and US retail sales are important indicators for the longer term.
The juxtaposition of Monday’s markets – China returning to work following its Lunar New Year holidays and the US closed for President’s day – may make for an interesting liquidity trade off. Given the moves in financial markets there is still the real possibility of Chinese policy action as we come into Sunday.