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Markets - The age of stagfusion

2016-09-15 12:51:12

Sep 12th 2016, 14:12 by Buttonwood

TRADERS are now back at their desks, and markets are getting active again,

after a somnolent August. Friday saw the first significant sell-off (in both

bonds and equities) for a while and the trend continued on Monday morning.

German ten-year yields have soared to 0.03%.

The proximate cause seems to be central bank action and inaction. The Federal

Reserve looks more likely to increase rates this year while the European

Central Bank (ECB) failed to add any stimulus last week. The narrowing

presidential polls in America (and the health scare for Hillary Clinton) can be

thrown into the mix; there is not the usual investor enthusiasm for the

Republicans, given the nature of the nominee. (Indeed, fund managers polled by

Bank of America see a Turmp win as the second biggest risk after EU

disintegration).

But the underlying problem needs a new word stagfusion. Investors have become

used to low interest rates and bond yields since central banks started to

loosen policy in 2008. They have prospered from it, since asset valuations have

risen and corporate profits have held up well, particularly in America. But

they also grumble about it from time to time. Hedge-fund libertarians dislike

the amount of official intervention in the market; pension funds and insurance

companies have seen their liabilities rise because of lower yields; strategists

and economists worry about the prospect of secular stagnation, a prolonged

period of slow growth.

So investors are confused. They recognise that a world of zero interest rates

and negative bond yields is inherently strange and problematic and fear it can

t last forever. But they worry what will happen when they cease to benefit from

all that central bank support. Perhaps stagnation is better than the

alternative? Hence stagfusion .

And judging by the comments of the central bankers, investors aren t the only

ones to be confused. Many central bankers seem to worry that monetary policy

has done as much as it can, and that economies need structural reform (and

fiscal stimulus) if they are to prosper. They are also conscious of the fact

that they are getting dragged into the political arena and this makes them

uncomfortable. But they have mandates to meet, and if the other reforms do not

happen, what else can the Bank of Japan, the Bank of England and the ECB do but

stimulate? Meanwhile the Fed is clearly terrified of making the kind of

premature move that sabotaged the 1930s recovery (or Japan s in the 1990s). As

we have seen, big market moves may cause them to think again.

So we have what therapists might call an unhealthy relationship between the

central banks and the markets in which each is nervous about the other might do

and the latter is terribly dependent on the former. And divorce is out of the

question.