Ducking the Fight
Having moved broadly in the same direction since the financial crisis, monetary policy across developed economies has started to diverge. While the US and UK central banks have begun tentatively to tighten monetary policy, the European Central Bank (ECB) and Bank of Japan are moving in the opposite direction. What are the implications for investors?
The US Federal Reserve's initial comments on tightening prompted considerable disruption in markets but subsequent shifts in monetary policy have been subject to the law of diminishing returns. The recent ECB announcement, for example, pushed peripheral eurozone bond yields to their lowest level since before the crisis and caused a brief bounce in equity markets. Meanwhile Bank of England governor Mark Carney's announcement last week that UK interest rates might rise as soon as August of this year prompted a sharp but short-lived sell-off in markets.
However, monetary policy is still likely to prove an important consideration for investors. After all, they only have to look at the impact of the withdrawal of US quantitative easing on flows into emerging markets funds to realise its potential impact on returns.
In areas where monetary policy is easing, bonds now look an increasingly precarious investment – for example, the 10-year UK government bond yield leapt 0.5% on Carney’s comments. Although it is possible to argue that markets should have known the direction of travel for interest rates, the timing has been subject to considerable speculation and conflicting statements from the Bank of England.
It is difficult to find a multi-manager who retains any exposure to US or UK government bonds and increasingly tricky to find one with investment grade bond exposure. Most are sticking with strategic or long/short bond funds, retaining the flexibility to move into areas such as asset-backed securities or floating rate notes, where there is more value and less vulnerability to interest rate rises.
Another important consideration is whether there are opportunities in those equity markets where monetary policy is being loosened. As ever, the danger is that what investors gain in the shares, they lose on the currency. However, for new investors, there may be opportunities. The euro has already depreciated against the pound. ECB president Mario Draghi’s policies should stimulate the meagre recovery in Europe and a weaker currency will help. The case is less clear-cut for Japan but corporate earnings are improving.
Investors cannot afford to ignore the implications of monetary easing on their portfolios and it will impact markets over the next 12 months – particularly if there are any more Carney-style surprises. History tends to suggest investors are usually better off not ‘fighting the Fed’ – or indeed any other central bank.
Posted by Paul Burley on
23 June 2014 at 12:00 AM
ECBemerging marketsMario DraghiMark Carneymonetary policyquantitative easingUK government bondsUS Federal Reserve