On more than a few occasions in recent months, markets have appeared rudderless, lacking direction and conviction beyond a knee-jerk preference for safety and for yield. Macro news since the start of the year has included the Swiss currency shock, the European Central Bank’s launch of quantitative easing, the Greek election, serial interest rate cuts, currency pressures and further declines in oil prices. In such circumstances, the demand for yield, evident in the strength of US Treasuries, becomes in part understandable even as the likelihood of higher US interest rates has risen.
The decline of bond yields in the face of a likely normalisation in US monetary policy was also one of the main themes of last year , and caused much consternation at the time. Now, after the run of recent global surprises, the downwards trend in yields is no longer questioned, despite the Fed becoming more confident about the economic outlook and more intent on ending zero rates this year. Markets have become increasingly selective, focusing on news items that reinforce the prevailing trend rather than thinking about ones that oppose it.
Oil prices are another example of this selectivity, with investors viewing oil price declines through one particular prism, but by doing so they lose sight of the big picture. Markets have been quick to price in the inflation effects of oil price falls, but have not yet priced in the implications for growth. These are clearly positive, especially in advanced economies, but also in many emerging ones, and they are especially compelling when combined with other stimuli coming from weaker currencies and falling interest rates.
Instead of energy prices being seen as an outcome of various supply and demand variables, the oil price tail has been allowed to wag the dog. Concerns have grown that its weakness portends something worrying about the future, in this case a period of weak demand and even the possibility of deflation.
Part of the problem is that policymakers have allowed the narrative to become an overly pessimistic one and have not provided an alternative, more constructive perspective about the future. Downwards predictions to growth forecasts by the World Bank and the IMF have attracted much attention in recent weeks, and the IMF’s Christine Lagarde hardly ever speaks without warning that the recovery is “brittle, uneven and beset by risks”.
There are few policymakers saying that the prospects for global growth are actually good and improving. In the past, the US Treasury secretary or the chairman of the Federal Reserve could be relied upon to provide a strong narrative for recovery and a framework for thinking about the world’s prospects. The Bank of England and the German Bundesbank could also be looked to for strong leadership and opinions. Investors would stand up and listen when they spoke, and markets would move on what they said.
Today’s occupants, however, do not command the attention of the markets in the way that their predecessors such as Larry Summers or Alan Greenspan did.
This is not just about personalities, but also has a lot to do with a formulaic approach to policy communication called forward guidance that became popular in recent years. This attempt to explain and simplify the reaction functions of central banks into easily understandable concepts and rules too often became a substitute for leadership, conviction and alternative opinions – things that markets are sorely missing.
Not only this, but on too many occasions those simple rules often misled markets into expectations that did not materialise. As a consequence, the credibility of policymakers deteriorated in the eyes of the markets, leaving a vacuum in which they were left to interpret and react to events.
Against this background, it is perhaps no surprise that markets have appeared to be rudderless and selective when faced with significant global events, instinctively rushing to high yield and safe havens. Global policymakers have a role to play in anchoring these reactions and providing a more nuanced narrative about the way forward.
Tim Fox is the head of research and the chief economist at Emirates NBD.
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