Jackson Hole gathering looms for investors
The focus should be much more on ECB policy signals and less on the Fed
With a supportive US Federal Reserve, solid corporate earnings, a “goldilocks” global economy and ample liquidity muffling political and geopolitical spillovers, many investors head out on holiday with the comforting expectation of a quiet August for financial markets. Indeed, the only known major economic uncertainty this month relates to policy signals out of Jackson Hole, the annual central bank symposium. Even here, the focus should be a lot less on the Fed and more on the European Central Bank.
The past few months have been particularly pleasing for investors. Fresh records for major stock indices have come with low volatility and rotating market leadership that reduces concerns about dependence on a particular sector. Further boosting traditional investment portfolios, government bonds have behaved well rather than markedly sell off, as suggested by most historic correlation models. Orderly dollar depreciation has turbo-charged returns on US investors’ unhedged holdings of international securities in European, Japanese and emerging markets.
A mix of economic, policy and technical factors explain this comforting confluence. Last week’s solid US employment report offset some concerns about an economic soft patch there at a time of encouraging data out of Europe, also serving to feed the view that the global economy is enjoying slightly higher growth with no inflationary threat. This explains why the Fed, ECB, and Bank of Japan have signalled — yet again — that they are in no rush to moderate their exceptional stimulus. This was reinforced last week by the Bank of England deciding to leave rates unchanged despite inflation remaining above target.
Then there is the ample funding for markets. Corporate earnings have surpassed expectations with higher profits and bigger cash balances fuelling hopes for yet more dividend payouts, stock buybacks and M&A activity. Richer households continue to capture a disproportionate share of the incremental income generated by the economy, channelling a larger part of it into financial investments.
All of this could be disturbed by exogenous shocks (geopolitical or domestic politics) and/or endogenous ones (like a policy mistake or a market accident). Judging from history, August has tended to be a fertile month for this. Yet, this time, the outlook for August appears stable.
With plentiful liquidity having conditioned investors to “buy on dips,” it would take a major shock to dislodge investors from behaviour that, repeatedly, has proven highly remunerative, despite unusually fluid geopolitical, institutional and political conditions. While there is a limit to how far financial risk-taking can deviate from fundamentals, this gap has been adequately supported for now by central banks. All of which takes us to Jackson Hole, the most important event on markets’ August schedule.
At times, such as 2010 when Ben Bernanke introduced the move to “QE2,” this annual confab has been used to signal policy changes with implications for markets. But, this year, don’t expect this from Fed officials. They are more likely to reiterate the “steady as it goes” approach with the hope that the next monthly jobs report will contain more robust wage growth and higher labour force participation.
It is the ECB that could — and should — be signalling a higher probability of, and some greater details on, what it hopes will be two orderly policy transitions: a tapering of its large-scale securities purchases; and readying the market for interest rate rises. As the Fed has shown, this pivot can involve a “beautiful normalisation,” to borrow a term used elsewhere by hedge fund manager Ray Dalio — away from a period of prolonged reliance on experimental unconventional measures. But that’s easier to deliver on a standalone basis than in group dynamics.
Indeed, what should feature most among the market thoughts of investors on holiday, and I suspect it hasn’t done so sufficiently until now, is the question of how many systemically important central banks can effectuate the policy pivot without undermining the overall liquidity support that has been so critical for decoupling asset prices from fundamentals.
Mohamed El-Erian is chief economic adviser to Allianz and author of the book ‘The Only Game in Town’