Oliver Mangan Chief Economist at AIB discusses the current global market risk sentiment and fear over global economic health in our latest economics blog.

Gripped by fear, markets need time

Gripped by fear, markets need time

Risk-off sentiment has dominated financial markets year-to-date, largely driven by concerns over the health of the global economy and doubts about central banks’ policies, especially negative interest rates writes Oliver Mangan Chief Economist at AIB

Equities have taken a hammering. The FTSE All-World stock index fell into bear territory last week, having declined by more than 20% from last year’s peak. Benchmark bond yields have declined by some 50 basis points year-to-date, with 10-year Japanese yields turning negative, German bund yields falling to 0.2%, while 10-year UK gilt yields hit a record low of 1.3%. These extremely low yield levels are seen by some as a signal for the onslaught of a global recession.

 

There has been a major shift in market expectations on interest rates. The Bank of Japan stunned markets by unexpectedly moving to negative interest rates in January, while the ECB also caused a surprise last month in hinting that it was likely to loosen policy further in March.

 

The big changes in the outlook for rates, though, have been in the US and UK. The US Fed’s projections in December showed four 25 basis point rate hikes were likely in both 2016 and 2017.

 

Now markets do not expect any US rate hike until the end of 2017. In the UK, the view now is that it could be 2019 before we see a rate increase.The unwinding of rate hike expectations in the US and UK and heightened risk aversion in markets have seen the dollar and sterling weaken, while the traditional safe-haven currencies — the yen, Swiss franc and euro — have all strengthened. And Brexit concerns are adding to sterling’s woes.

 

The turmoil in markets seems to be driven by fear rather than economic data or any one particular event. The major economic release year-to-date, the US employment report for January, was very solid. Most other economic data have generally held up in recent months.

 

There are concerns, though, about the weakening of growth in emerging economies and their high debt levels, with particular worries over China. However, there has not been a marked worsening recently in the economic data for emerging economies. Meanwhile, data on China generally do not point to an acceleration of the slowdown in that economy.

 

Markets, though, seem to be losing faith in the effectiveness of monetary policy as more and more central banks opt for negative interest rates and hint policy can become even more expansionary. They are worried about whether central banks can sustain the recovery. Perversely, a new concern is that the volatility and weakness in financial markets will feed through into the real economy via its impact on confidence and business investment, as well as via negative wealth effects.

 

In other words, markets could generate a downturn whereby sharp falls in asset prices leads to a decline in economic activity.There is the most serious setback in markets since the financial crisis of 2008-2009. The falls in riskier asset classes such as equities are substantial. Given the very poor risk sentiment at present, the best that can be hoped for markets is that they stabilise around current levels — that is: Bounce along the bottom. Much attention will be focused on upcoming economic data to see if market fears of a recession are justified. This could set the long-term direction for markets. The financial turbulence is a negative for economic growth, but as the US Fed has pointed out, the sharp fall in long-term interest rates is an offsetting factor that should help sustain activity in advanced economies.

 

Emerging economies, though, will require close monitoring as some have been hit by severe shocks. Signs of a stabilisation in commodity prices would be a welcome development for many of these economies as they are large commodity producers. Overall, we are not convinced that a global recession is at hand. However, for nervous financial markets, it may take some time for them to recover.

 

Source: Irish Examiner February 16th 2016

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