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2014-10-16 08:47:25
Oct 15th 2014, 15:13 by Buttonwood
MAY you live in interesting times. The old curse seems apposite today, as markets get lively again. As I write (and things can change rapidly) the Euro stoxx is down 2.6%, the S&P 500 has opened 1% down (and is in negative territory for the year), ten-year Treasury bond yields are down to 2.03% (they were more than 3% at the start of the year), Greek bond yields are getting close to 8% (and its stockmarket is almost down 20% on the year), oil is down in the early 80s a barrel, volatility has spiked, high yield spreads have risen...the list seems endless.
Such jitters are a regular feature in Octobers past and have been coming for some time. As I wrote last month, there was a mismatch between what equity markets were implying, and the message from bond and commodity markets. It seems to have been resolved in favour of the latter.
The big fear is deflation. We will get figures from the euro zone tomorrow for September but even the UK, which missed its target on the upside for more than three years, is down to an annual rate of 1.2%. US producer prices fell last month, and are up just 1.6% year-on-year. More pertinently, perhaps, ten-year inflation expectations (as measured by the bond market) have fallen to less than 2%. In a sense, the falls in the euro and the yen could be seen as a way for those regions to export deflation to the US.
Meanwhile, global economic growth forecasts have been revised down. In the summer, people thought the strong US economy would drag the rest of the world up; now they fear the rest of the world might drag the US down. Today's news of a decline in retail sales and in the Empire Fed index will add to those worries.
Julien Garran of UBS published a note in August on the "four horsemen" of the apocalypse that might herald disaster - weakness of deficit-plagued emerging market currencies (such as South Africa and Turkey), falling Chinese steel prices, a drop in tech stocks like Tesla and Neflix, and widening spreads on high-yield debt. Three of those horsemen have arrived.
But never fear. Maybe the central banks will ride to the rescue as they have so often in the past (1987, 1998, 2002, 2009)? In a way, you could see the market sell-off as a toddler tantrum; they want more from their Mummies and they want it NOW.
Market expectations of Fed rate increases have been subjected to a sharp adjustment; rates are expected to be 1.75% in late 2017, below the lowest "dot" in the projections revealed by the Fed only last month.
Not raising rates would be a help. But it is not as good as cutting rates, or restarting QE. And the markets would also love it if the ECB adopted QE, but the bank may be waiting for the news to be bad enough to overcome German objections. So that leaves the markets in a hiatus.
As Mr Garran writes
Should investors' faith in the Fed's ability to deliver us from deflation be tested, and should they instead start to suspect that the Fed is instead delivering us into deflation, this would risk a break in markets
Regular readers will know I am not QE's greatest fan, and it certainly shouldn't be used to bail out the markets (which only adds to inequality). But there is no argument for raising rates with inflation so low and falling; central banks should make clear it's not going to happen. And there is a very good argument for fiscal stimulus in those countries (like Germany) that can afford it.