The ‘lower for longer’ environment that we are experiencing has required central banks to adopt some extraordinary measures. Most recently the Bank of Japan adopted negative interest rates and the European Central Bank pulled multiple levers including cutting the depo rate by 0.1%, increasing quantitative easing and opening it up to non-financial corporate bonds, as well as introducing a new series of four-year targeted long-term refinancing operations (TLTROs). These measures, along with an upswing in corporate profitability and growing signs of stability in credit markets, have helped provide a backdrop against which risk assets look more benign. They have certainly resulted in a wild ride for banks.
Our view is that, in Europe at least, the ECB measures are probably a net positive for bank earnings and banking pressures should diminish from here; but market sentiment is still ‘see-sawing’ between confidence that central banks absolutely have enough in their policy toolkits to avert deflationary pressures and stimulate growth, and fears that those toolkits do not have a lot left in them – as seen by initial reactions to the ECB closing the door on further rate cuts.
In the US, a host of market participants had been circulating expectations that the US could be heading into recession this year, but economic data has begun to turn, with very strong US employment data in particular coming hot on the heels of other economic surprises, helping to ease financial conditions. But we must bring China in here. As China-watchers, we are trying to interpret whether the recent improvement in sentiment is backed up by real or imagined economic improvement. Clearly, none of the structural issues we have identified previously appears to have been addressed: the central bank is targeting a 6-6.5% growth rate this year and the liquidity taps have been turned on but, ultimately, we believe China is experiencing a cyclical rather than a structural improvement as the PBoC tries to ease the pace at which economic growth decelerates. For the US, the key question is one of divergence: is the Fed able to adopt monetary policy that diverges from ECB and Bank of Japan actions and operates independently of spillover pressure from the China slowdown? We believe the US dollar is ready for another leg-up, but it needs a catalyst such as the Fed raising rates – that may not happen until June.
Brexit uncertainties persist. The online polls seem unambiguously to be coming out in favour of leave, whereas the phone polls are unambiguously favouring remain – by a wide margin. Central establishment figures have entrenched themselves on both sides of the debate but this has not lessened the uncertainty, that is only intensifying as we move closer to the 23 June referendum. Sterling has been the main mover in this, with market forecasts indicating 1.50 against the dollar is the appropriate valuation for remain and 1.20 an appropriate valuation for leave. As the polls change, so Sterling gets battered about. How markets change in the run-up to the referendum will be interesting. The uncertainty is putting ever more distance between the Bank of England moving interest rates – despite relatively good labour market numbers – with our valuation research indicating the first rate rise in April 2019, though some analysts have pushed that back to 2020.
Mark Burgess is CIO EMEA and Global Head of Equities at Columbia Threadneedle.
