Are central banks wary of bouts of March madness?
March is notable for spells of market mania and this month also incorporates important deadlines that have long been indicated as possessing the potential to precipitate renewed financial stress. Not for the first time, a postponement to the time of reckoning is a reasonable conclusion. That should provide a false calm across markets that at some point will break. Accompanying the vigorous performance of speculative assets so far this year is the outcome of Sino-US trade negotiations, Brexit and how long the Fed remains in “pause” mode. These challenges remain wild cards for investors, and this week the hint of practical outcomes on trade and Brexit sparked warm market returns in Chinese shares and the pound.
Investors should be watchful, nevertheless, that any suspension does not prohibit the risk of a dangerous reaction. Starting with trade, it prevails to be determined whether definitive progress is produced on issues beyond tariffs, such as protecting intellectual property and ending regulatory restraints on US investments.
Meanwhile, it is foolish to accept the high performance of Chinese markets so far this year, as proof that trade agreements will precipitate a compromise that supports global activity. As to be complacent is to neglect two significant issues. Beijing’s dose of liquidity into the financial system is already more pumping up share prices in a market that has fluctuated over the preceding decade and now sits about a third below its 2015 peak. The entry of the retail punter in China has been attended by a deluge of overseas money into mainland asset classes ahead of MSCI, the index provider, upping the country’s weighting in its emerging markets benchmark.
Turning to Brexit, a postponement beyond the March 29 deadline or perhaps an acknowledgement of Theresa May’s current deal, is better than a hasty exit. But the road remains challenging for the UK, notably if a second referendum becomes a reality. That is why the pound will find it tough heading higher than the $1.40 level, which used to be a multi-decade floor versus the US dollar prior to the UK’s vote to leave the EU in 2016. Whilst there remains little certainty on longer-term prospects as Brexit drags out, weighing on faith in the economy and in UK businesses. The wild cards of both trade and Brexit resonate with the Federal Reserve. Last week chair Jay Powell cited both issues during his semi-annual testimony before Congress as reasons the US central bank should be circumspect.
Mr Powell’s focus on preserving a supportive approach for markets may be tested should important economic data show proof of resilience. A risk flagged to some degree by this week’s rise in Treasury yields. For now, the dovishness of central banks led by the Fed explains why markets are seeing beyond the risks presented by a disruption in trade negotiations or hard Brexit outcomes might prompt greater monetary stimulus. This insurance wrapper known as a “policy put” helps justify the present moribund state of implied volatility for equities, bonds and currencies. Higher market volatility was sparked last year by the Fed’s tightening, but now the uncertainty is that lackluster economic growth is not negated by central banks going to the rescue. For investors, the current regime of low market volatility provides one silver lining; insurance is cheap and desirable of consideration before the next spell of turmoil erupts.