RISK ASSETS SAG WITH CENTRAL BANKS ON HOLD
FX360
INVESTOR sentiment has turned less bullish over the last couple of months, with a marked pull-back in risk assets since the beginning of May. This contrasts with the sharp rally in major global stock indices, precious metals and oil that ran throughout the first quarter of this year.
The current sell-off followed the news that the Federal Reserve, the European Central Bank and the Bank of England were all prepared to hold off from further intervention, preferring to monitor developments until their next respective meetings. At the end of April, the Fed’s Open Market Committee was only a touch more upbeat about the economy than it had been in January, while indicating a raised concern about inflation ticking higher. Yet in the press conference that followed, chairman Ben Bernanke blamed rising fuel prices for a “temporary bulge” in inflation, which he expected to moderate going forward. He left the door open for further stimulus, saying that additional easing “remains on the table.”
Following its rate decision on 3 May, ECB president Mario Draghi was more hawkish than many analysts expected. He expressed the view that more time is needed for the full effects of the €1 trillion Long-Term Refinancing Operations to work through the financial system. So despite the troubles across Europe, the ECB remains in “wait and see” mode. The Bank of England’s monetary policy committee also refrained from adding to its own asset purchase programme. But keeping the stimulus ball in the air, the Bank of Japan added an additional ¥5 trillion (£38.7bn) to its asset purchase programme (at the bottom end of expectations), while the Swiss National Bank continues to add liquidity as it prints francs in an increasingly desperate struggle to maintain the SFr1.20 floor.
Recent economic data out of China points to a slowdown. Manufacturing PMIs have been ambiguous, but the latest trade data suggests that the growth rates for imports and exports are declining. Last Friday, CPI and PPI moderated a touch indicating that inflation may be stabilising, while industrial production fell sharply month-on-month. With China’s policymakers downgrading the country’s GDP outlook to 7.5 per cent from 8 per cent in 2012, some market participants believe that this heralds a more accommodative phase of monetary and fiscal policy in the months ahead. But there has been a marked slowdown in the growth of China’s foreign exchange reserves, thanks to weakness in many of China’s export markets. This mitigates against a loosening of monetary policy, and this week’s 50 basis point cut in the Required Reserve Ratio was widely viewed as an irrelevance.
But it is the US Federal Reserve and the ECB which really matter. The ECB’s next meeting is on 7 June and the Fed’s is two weeks later. This means that investors have to evaluate the risks in holding financial assets with the central bank liquidity tap turned off, and an increasing number of them are deciding to bail out. The political impasse that has followed the Greek general election has raised the probability that Greece will leave the Eurozone. Yet while the vast majority of Greeks voted for anti-austerity parties, these are usually the same people who desire to keep the euro as their currency. But whether Greece exits or not, the Eurozone is in trouble. Of course, this means that the global banking system is in trouble too. Spain has just part-nationalised Bankia (its fourth largest bank) less than a year after it was floated and sold to the public as a solid investment. In addition, JP Morgan’s $2bn-plus “hedge” loss is a stark reminder of just how opaque bank balance sheets are; how overleveraged many financial institutions may prove to be and how nothing has changed fundamentally four years after the Great Financial Crisis first hit. Much more of this and we won’t have to wait until June for the central banks to get the excuse they need for further intervention.