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COLUMN-Teflon markets still betting on central bank backing: McGeever
June 21, 2017 / 10:05 AM / 6 months ago

COLUMN-Teflon markets still betting on central bank backing: McGeever

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever

LONDON, June 21 (Reuters) - It is the conversation dominating and worrying world markets in equal measure: is there anything on the immediate horizon that will snap the “Goldilocks” cycle that has sent volatility to historic lows and stock prices to record highs?

It appears not. This month the Fed raised U.S. interest rates again and said it will soon begin reducing bond holdings, the Bank of England moved closer to raising rates than at any time in a decade, and world economic data disappointed.

Tighter monetary policy or a significant deterioration in the outlook for growth - at least relative to expectations - would normally be red flags to investors, and potential triggers for a pick up in volatility and a pullback in stocks.

Yet implied volatility on Wall Street is at a record low, and U.S., UK, German and world stocks are at record highs. World stocks look set for the eighth monthly rise in a row, the best run for more than 13 years.

Every market dip is met with a wave of buying, suggesting that faith in the central bank “put” is as strong as ever. Ultimately, investors are betting the Fed and its central bank peers have their back, despite the relatively hawkish noises coming out of the Fed.

This refers to the perception that central banks will do whatever it takes to avoid the financial and economic damage a crash would unleash. Essentially that means maintaining a loose monetary policy and the flow of liquidity into financial assets.

It is a view borne out in the U.S. bond market, where the gap between short-dated and long-dated yields is the smallest since 2007. The flatness of the yield curve shows that investors do not believe the Fed will tighten much at all.

SURPRISE, SURPRISE

The central bank prop of trillions of dollars, euros, sterling and yen of stimulus has powered the global economic and market rebound from the 2007-2009 crisis. The danger now is complacency.

With yields so low - a consequence of central banks’ massive bond-buying programmes - investors are taking extra risks by seeking returns in markets or regions they would not normally venture in. Valuations get pushed higher and bubbles form.

Investors have had no shortage of potential minefields to navigate over the past year, including the political shocks of Brexit and Trump’s election, rising tensions between the West and North Korea, and a heavy European election calendar.

Some of those risks have been more benign than feared and some have yet to play out at all. But nothing on the political front has derailed markets, mainly because the global economy and company earnings growth have been humming along nicely.

World growth is ticking along steadily, and according to Fitch, will rise to 3.1 percent next year, the fastest rate since 2010. According to JP Morgan, global economic volatility has not been this low for 40 years.

Global earnings growth is forecast at about 12 percent for the next 12 months, the fastest rate since 2011.

But the growth picture has darkened this month, at least relative to lofty expectations, if Citi’s range of economic surprises indexes are anything to go by.

The U.S. and G10 developed economy surprise indexes are on course for their biggest monthly fall for six years, and the UK index its biggest fall since 2009. Both the U.S. and UK declines will be the third largest on record.

Yet world stocks have barely blinked and volatility is historically low.

“The longer volatility remains low the more fragile the system gets, the more leverage is applied, the more people sail closer to the wind,” said UBS Wealth Management chief investment officer Mark Haefele, with about $2 trillion under management.

“The real shock is if people start to believe that the central bank put is no longer in place. And we’re nowhere near that point yet.”

Editing by Louise Ireland

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