This week’s misquotation comes courtesy of EM Forster (in Howards End) but is there a better way of describing market performance during another month of mixed to poor economic data? October is typically the worst month of the year for many equity markets but 2015 turned out even better than 2011, with all those that I monitor closing higher, albeit with a few wobbles at the very end, Market sentiment appears to have improved during the month and the most likely explanation is deeply unsettling. It is not really about confidence amongst investors in central banks and classical monetary policies but rather that algorithmic programmes are trading on the assumption that most investors either have such confidence or are too scared to bet against it. This seems unsustainable and the October cornucopia may threaten the hitherto widely expected Santa rally There is still just about scope in the US for another push higher but portfolio investors elsewhere must be tempted to wrap up the year soon while the going is good. There seems little prospect in the next two months of major good news to justify hanging around unless one is looking for trading opportunities.
Chart 1 – Probability of FOMC hiking rates
Never fight the Fed?
This maxim has stood up well over the years but, as Chart 1 shows, markets have become more sceptical that FOMC members mean what they say, not least with their famous dot diagrams forecasting their own future decisions. Last Wednesday, the Committee wrong-footed dovish investors by indicating that a rate hike in December 2015 was very possible if not a done deal. Even now, however, it appears that investors place less than a 50% probability on that happening and a 5% probability that it will still not have happened by the end of 2016.
At the risk of oversimplifying, there are three alternative ways of describing the state of mind of ‘mainstream’ Committee members, based on last week’s Statement:
Delusion: Monetary policy is working in the US and Personal Consumption is sure to push annual GDP growth back above 3%. China’s official data may be a little massaged but Consumption will come good here too. Other central banks will do their bit to boost both growth and inflation. An early hike will create the opportunity to cut again if things go awry and especially if the dollar surges out of control.
Cynicism: the FOMC’s credibility is now on the line after months of conflicting signals. One rate rise is unlikely to do much harm and many investors will be fobbed off by a ‘wait and see’ approach to subsequent hikes. Meanwhile, the rest of the world can go hang.
Realism: no matter how successful QE and ZIRP have been hitherto, their efficacy appears to be waning in respect of business investment and hiring new workers. There is currently no macroeconomic case for a series of rate hikes but the mere possibility could help with an orderly deflating of price bubbles in equity, debt and housing markets as well as discouraging hot money leaving the US at the drop of a hat.
It would be nice to think that realism was prevailing but more likely is a combination of delusion and cynicism being outweighed, at least at the next meeting in five weeks’ time, by a new outbreak of dovishness. Accordingly, no rate hike soon in the US.
So, what of the other Masters of the Universe? Despite his occasional lapses into vanity Mr Carney and most if not all of his MPC colleagues seem generally inclined towards realism. For some time now they have accepted that the impact of QE is diminishing and apart from the sparky Andy Haldane (who may well be kite-flying with his boss’s blessing) have resisted siren calls for zero or negative interest rates. Nevertheless, it must a bit annoying that the market boxes them in to a position where they can do little other than wait for the Fed, not least that it pushes up sterling.
Alas, in their different ways the ECB, BoJ and PBoC seem seriously deluded. Mario Draghi has more reason than most to feel he can move mountains with his defence of the euro but it is hard not to believe that his hubristic pronouncements have little effect on the real economy but instead provide punting opportunities for international speculators in equities (especially the DAX) , sovereign EZ bonds and, naturalamente, the euro. Chart 2 shows how both his expected and actual interventions in January, March and October have prompted shorting EUR/USD (the lower the white line the larger net short positions) thereby driving the spot rate lower (blue line), which Mr Draghi grandly asserts is not a formal ECB goal (ahem!).
Meanwhile, Haruhiko Kuroda also wrong-footed markets last week by failing to respond to the continuing stream of soft to awful economic data in Japan. He did not come across as any less deluded than previously but maybe he now secretly believes there is not much that monetary policy can do in his patch. In contrast, central bank inaction is not permitted in China as Mr Xi puts Communist Party imperatives above everything else. A sixth interest rate cut in less than a year suggests that neither the PBoC nor the economy at large have fully understood him!
Chart 2 – Punting on Draghi EUR/USD since Nov 2014