A dovish symphony for equities
FT subscribers can click here to receive Market Forces every day by email.As a flurry of central bank meetings concluded on Thursday, equities showed all the usual signs of looking on the dovish side. The FTSE All-World index nudged into the green for the week, but completing a streak of four straight weekly gains is being challenged as Wall Street retreated from a test of record territory earlier on Thursday and gave up all its gains.
Equities are supported by low bond yields and central banks leaning towards further easing should hopes of better tidings on global trade and economic data fail to materialise in the coming weeks. The flipside is that further gains look tough unless data improves and there is some progress between the US and China over trade.A look at proceedings over the past 24 hours shows the US and Brazil cut rates. The Bank of Japan remained on hold at minus 0.1 per cent, but opened the door to easing in October. Both the Bank of England and the Swiss National Bank stayed pat, but the BoE struck a dovish tone by suggesting Brexit uncertainty and a weak global economy could spur a rate cut. The SNB also slashed both its growth and inflation forecasts for the year while alleviating some of the negative rate pain for banks. Thursday’s outlier was Norway, with a rate tightening, but that appeared the limit for now and was viewed as a “dovish hike” in the vernacular of markets.But a cloudier economic horizon was highlighted on Thursday by the OECD cutting its 2019 global growth forecast to 2.9 per cent from 3.2 per cent, which would be the world’s weakest performance since the 2008-09 financial crisis. The intergovernmental body said the outlook was “increasingly fragile and uncertain” thanks to trade tensions.
Laurence Boone, the OECD chief economist, issued a warning about the likelihood of stagnation:“The danger is that we get into a vicious circle of lower trade, investment and higher uncertainty”And here are the OECD’s downgrades for 2020:
Cheery stuff, but for markets this appeared to be the case of yesterday’s news. Portfolios based on a mix of growth/quality and defensive equities along with a ballast of government bonds were built for this outcome and they have been doing nicely so far in 2019. Meanwhile, sentiment is leaning towards a recovery story, which explains the recent rebound seen in value across share markets.Brad Bechtel at Jefferies notes:“Central banks have fired a lot of bullets and ISMs around the world have taken a lot of pain, but it feels like the worst could be over. Especially if we get a China/US deal.”Over at the Institute of International Finance, it also struck an upbeat tone, noting:“Our best leading indicator for global growth — the combined weight of manufacturing PMIs from around the world that are rising — troughed in Q2 and has been rising in Q3, a positive signal for global growth . . . especially since services sectors have proven relatively immune to manufacturing weakness.”Another element helping soothe risk appetite on Thursday was a decidedly mixed performance by the US dollar. A day after the Fed sent the message that there was a higher bar for further rate cuts, the lack of broad dollar strength suggested the currency market begged to differ.But renewed dollar strength and the price of oil are important issues for many countries that are big crude importers, no less than for the eurozone.Neil Mellor at BNY Mellon says:“Higher energy costs coupled with USD strength would pose a particular test to those heavy oil importers struggling to maintain an even keel, like the eurozone.”Neil adds:“A weaker currency would serve the bloc’s export model, but the prospect of a potentially punitive uptrend in oil prices would skew the cost-benefit ratio of a weaker currency deep into unfavourable territory.”Bank of America Merrill Lynch is also casting an eye across the euro, with weakness seen more as a case of dollar strength though a healthier economy. But there are other concerns, such as Brexit and US and European trade talks. BofA note:“The market has been focusing on the US-China trade talks, but we are also concerned about the US-EU trade talks. The market is underpricing the negative implications of a no-deal Brexit for the eurozone. The latest sharp increase in oil prices and a potential major escalation between the US-Iran tensions is another risk.”Quick Hits — What’s on the markets radarThe New York Fed kept the fire hose open, rolling over $75bn of overnight repos, with the operation attracting $84bn in demand earlier on Thursday. There was certainly some frustration in the bond market that Jay Powell, the Fed chairman, during his press conference did not outline in detail steps the central bank would take to alleviate the funding stress. What we heard from Mr Powell was:“I think for the foreseeable future, we’re going to be looking at, if needed, doing the sorts of things we did the last two days. These temporary open market operations — that’ll be the tool we use.”The next test for repo liquidity will be the end of the current quarter as the calendar flips to October, which has sparked calls for term repos that can cover an extended period of, say, 10 days. Before 2009, the NY Fed had a book of term repos that included 7-, 14- and 28-day periods. The bond market is focused on looming big sales of Treasury debt, which must be financed via the repo market — and this cuts to the heart of the issue. Banks’ cash reserves have shrunk to a level that leaves little room to absorb ever-growing amounts of US government debt sales. Lou Crandall at Wrightson Icap says the Fed is following “a three-phase response to the funding squeeze”. Lou adds:“We thought the Fed would ad-lib its way through the end of this month, ramp up work on the design of a long-term standing repo facility and outline a medium-term strategy for temporary open market operations as a bridge to get us through year-end and perhaps the April tax season while the SRF [standing repo facility] is under construction. In broad terms, that still seems like a reasonable approach.”Some in the bond market wearily note that the topic of a standing repo facility has been making the rounds for a while with little sign of progress. It’s also noteworthy that Simon Potter abruptly left the NY Fed in late May as head of the Markets Group. At the time, there was concern among some in the bond market about such an experienced official leaving the NY Fed, and this week’s funding stress has underlined why there was such angst earlier in the summer. Your feedbackI’d love to hear from you. You can email me on firstname.lastname@example.org and follow me on Twitter at @michaellachlan.