The third quarter ends with the obsessive focus on global central banks pivoting towards the election, a focus that will surely become even more obsessive as the final vote is counted. The differences between the candidates are stark, and their respective policies matter for investors, whether it’s related to energy, healthcare, trade, banking or taxes. But just as markets unraveled immediately following the Brexit vote, the intense anxiety was relatively short-lived. Markets adjusted, and so too will the election lead to a period of acceptance regardless of who is sworn in as president next year. In fact, it won’t take too long before we start hearing about who’s visiting Iowa and New Hampshire on a regular basis. This is the nature of markets, always looking ahead with an opportunistic eye.
The fourth quarter still has to work through significant issues, however, besidesthe election: central bank concerns, particularly with regard to their ability to foster demand, growth and inflation with the tools they have available; questions focused on earnings reports and whether or not we’ve seen the end of the earnings recession; and the seemingly unrelenting tug-of-war between the bulls and bears over the strength of the U.S. – and global – economy. As central bankers and their economist brethren remain data dependent, so too do markets, be it currencies, Treasury and global sovereign yields, commodities, equities or fixed income.
By the time the calendar turns the page to 2017, we should have some answers, more questions and considerable debate on where the economy and markets are headed. For the time being, though, we’re in the home stretch.
CENTRAL BANKERS LOOKING DEEP INTO THEIR TOOL KITS
September was an important month for investors as central banks, from the European Central Bank (ECB) to the Bank of Japan (BOJ) and the Federal Reserve, were expected to offer extended stimulus measures. Even the Fed, despite Chair Yellen’s earlier comments suggesting a rate hike was likely before the end of 2016, was expected to keep rates steady at its September meeting. Haruhiko Kuroda, head of the BOJ, was to unveil a “comprehensive assessment” of his easing program, in place since 2013. Analysts predicted that the ECB’s Mario Draghi would announce that the ECB Quantitative Easing (QE) program would be extended beyond its March 2017 deadline, with some strategists suggesting that he would also signal a broadening of the type of assets to be purchased. The results, however, fell short of expectation, with financial editorials declaring, “The Growing Challenge to Central Banks’ Credibility” (Financial Times) and “Central Bankers at Wit’s End” (The Wall Street Journal). The New York Times in August, while applauding the Fed’s low rate policy, lamented the lack of fiscal measures to help bolster growth, “low rates need to be paired with federal spending and other fiscal support. Here the Republicans have been of no help.”
The BOJ did, in fact, surprise markets by announcing that it would target the yield curve in a move aimed at pushing up long-dated bond yields with regard to short-term rates.
This is considered friendly to banks, insurance companies, and pensions. It is designed to give yield-hungry institutions a much-needed reprieve from the effects of negative interest rates. That said, the whisper surrounding yield curve targeting, is that the BOJ is running out of bonds to buy under its quantitative easing program. In addition to purchasing more ETFs, the BOJ pledged to overshoot its 2% inflation target “at the earliest possible time.” Questions remain if the BOJ can maintain its commitment on inflation since in 2013 Kuroda set a 2% inflation goal that was to be met by 2015. Now investors are waiting to see if Prime Minister Shinzo Abe does more to push for structural reform following the August announcement of a major stimulus package. His most recent comments indicate a less aggressive stance on the labor reforms investors were hoping for.
The ECB meeting surprised markets by doing very little save for disappointing investors. Analysts still think that Draghi could extend the bond buying program currently in place beyond its March 2017 deadline, or announce a newly structured program that would open the possibility for other targeted purchases.
Draghi stressed that while monetary policy will continue to support the economy and ensure price stability, consistent with central banks’ mandates, “monetary policy alone cannot lead to balanced growth.”
Conservative German politicians are demanding that the ECB change course and allow rates to rise so pensioners, savers, insurance companies and banks can benefit.
The rhetoric has intensified to the point that Mario Draghi’s policies were blamed for the rise of the far right party, the Alternative for Germany (AfD), a group that began in opposition to eurozone bailouts and now has transitioned into the anti-immigration party. If the ECB intends to extend the March deadline and increase purchases to include other assets, it’s crucial that Germany is on board. Negative interest rates are also exacerbating the plight of Germany’s largest bank, Deutsche Bank, which has seen its share price reduced by nearly 50% in 2016. Headlines in Germany similarly blame the ECB’s policies for difficulties in the entire banking sector, but especially with regard to Deutsche Bank, once a global leader.
While the Federal Reserve was not expected to raise rates in its September meeting, Chair Yellen seemed intent, in a mildly hawkish way, on telegraphing that a rate hike could be coming this year.