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Market moves are now dictated by central bankers

Since March, the strong recovery in equity markets has mostly been due to the unprecedented monetary-policy stimulus the world's central banks have unleashed.

Washington DC Capitol dome detail with waving american flag

Jon Cunliffe

in Features


Since March, anyone watching stock markets has accepted that the world’s central banks have been firmly in the driving seat.  The strong recovery in equity markets has mostly been due to the unprecedented monetary-policy stimulus they have unleashed.

After a strong rally in equities over summer, September shows what happens when central banks take their feet off the accelerator pedal against the backdrop of unwelcome news on the spread of Covid-19.  

With the US Federal Reserve (Fed) easing the pace of its asset purchases, the European Central Bank wary of a further challenge on the legality of its QE programme – and no fresh ideas from the Bank of England or the Bank of Japan (BoJ), US equities succumbed to selling pressure. In September, the S&P 500 fell for the first time since March.

There were a few developments which may have been missed in the tsunami of news and events. In September, the Dollar index strengthened, US market-implied inflation fell, and corporate bonds underperformed their sovereign counterparts. This suggested that, at least for the time being, the powerful “reflation trade” which the global policy response had fuelled started to wane.  

In its September policy meeting, the Fed took the bold (but well-flagged) step of changing its inflation and employment mandates. An average inflation rate of 2% over the long term and maximum employment are now the desired outcomes. This means that the Fed will allow the economy to “run hot” for longer and, given current inflation forecasts, suggests no increase in Fed Funds until 2023/4 at the earliest. 

There has been scepticism about the Fed’s new targets, however, given the persistent undershoot of US inflation in recent years. With no current commitment to boost the level of asset purchases – or push the envelope of monetary experimentation – are these revised targets credible or achievable? Our sense is that, for the reflation trade to get back on track, the Fed and other key central banks will have to up the ante, which is something we now expect before the year-end.

The woeful relative performance of the UK equity market continues. Even adjusting for this year’s 7% decline in trade-weighted Sterling, the FTSE 100 has underperformed its European, US and Asian counterparts by a considerable margin. 

Whilst bad news flow on the UK economy and Covid-19 – as well as market concern over the Brexit narrative – are clearly factors; a lot of the underperformance of the UK stock market is attributable to the high weight it has in materials, oil and gas and financials – all of which have encountered severe headwinds in the current crisis. Whatever one’s views on the outlook for the UK equity market, it is reasonable to assume that a global approach to asset allocation is a better starting point than a home bias. 

The US election is now firmly on the radar. At the time of writing, the odds are in favour of Joe Biden by roughly 2 to 1. A democratic clean sweep (a 30% probability) is likely to be negative for US equities, given Mr Biden’s proposal to increase the corporate tax rate by 7% to 28%. Mr Biden or Donald Trump winning the White House, but under a split Congress, is likely to see fiscal gridlock – with more onus on the Fed to do the heavy lifting from a policy perspective. Only under a Trump clean sweep is the outlook for US equities in the months ahead unambiguously positive.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal. 

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