Despite the hype of the global monetary system heading for normalisation after over a decade of ultra-loose monetary policy, central banks around the world have lost their nerve. The US Federal Reserve being the most conspicuous with its Chair Jerome Powell essentially doing a u-turn on his rate hike pledges of last year.
For investment fund investors, this is not particularly bad news, especially in sectors like infrastructure where higher interest rates can really cut into returns. The damage seemingly caused by Powell’s forecasting four hikes this year was clear to see and markets are now pricing in a 75 basis point cut instead.
Some central bank decisions were obvious before the event; could the Bank of England hike rates with Brexit looming and no leader of the country? No, it could not. Nancy Curtin, Chief Investment Officer at Close Brothers Asset Management, went further, stating: “With Brexit unresolved, it is now practically inconceivable that there will be a rate hike between now and October, despite GDP growth being close to potential.”
It is the dichotomy of global growth and low interest rates that is at the heart of the sea change. Russ Mould, investment director at AJ Bell said: “With virtually every other central bank in the world taking a softer line in 2019 it would have been remarkable had the Bank of England taken a tougher stance on monetary policy.”
With fears of global growth slowing, it would take a brave central banker to hike rates. However, if rates continue to be lower for longer, there are some dilemmas which have to be addressed. Sovereign bond yields among developed nations are at all-time lows, with the highest rated govies often negatively yielding for years. Swiss ten year bonds yield -0.5 percent suggesting if investors want risk free returns, they have to pay for it.
Therefore income investors are forced to look at alternatives such as equity income funds. Having witnessed the spectacular crash of ‘star’ fund manager Neil Woodford’s equity income product, it would be a brave investor to enter the choppy markets now.
Also we are late in the market cycle. No one wants to predict a correction although we had two last year. ‘Things come in threes’ would be a rather unpleasant superstition to come to fruition in today’s markets.
If we suffer a significant correction, central banks are left with very few tools to combat it. Yes we could drive interest rates into negative territory but debt begets debt and with trillions of dollars already in the system, this could lead to a Japanification of the major global bond markets.
The reaction of the Bank of Japan (BoJ) to the Fed’s meeting indicating rate cuts was systematic. Mr Oshikubo, senior economist at Sumitomo Mitsui Trust Asset Management believes that there is an increasing possibility that the central bank will expand its quantitative easing program.
He said in a statement: “While there is not much room for further monetary easing by the BoJ, if it does not release statements on its future easing plans then the appreciation pressure on the yen will only increase.”
He added that there is still room for Japanese long term interest rates to decrease further as central banks around the world make a shift to monetary easing.
Navigating these perilous waters is going to be a challenge in today’s market, loose policy aids risk assets so given Fed Chair Powell’s comments it might not be too late to climb on board the S&P 500 index tracker gravy train.
However, Franklin Templeton Fixed Income CIO Sonal Desai, does not seem overly impressed by the apparent zig-zagging of Powell. He said in a statement: “Powell said that the shift in rhetoric in today’s statement had been driven by data and events that emerged in the last couple of weeks, and noted that new data and information would of course become available between now and the next Fed policy meeting. But if the Fed’s language is going to shift with every new batch of data, this seems to guarantee more swings like we have seen since late last year—causing more market volatility. It also contradicts Powell’s claim that the Fed wants to react to clear trend change, not to individual data points and shifts in sentiment.”
Rubrics Asset Management’s chief investment officer Steven O’Hanlon has his own take on Fed and global interest rate policy. His firm’s Global Credit Fund seems made for market volatility. He told Fundeye that the only year there wasn’t a buying opportunity for bank bonds at generous yields was 2017, a “perfect year”, before citing the numerous calamites of policy missteps including the now infamous 2013 ‘Taper tantrum’. It seems the year may be summed up by the somewhat hackneyed aphorism ‘One man’s meat is another man’s poison’.
