Investment Outlook for July
Over the course of June, it has become clear that the normalisation of monetary policies has become unfashionable, and that (very) low interest rates are likely to persevere. Unsurprisingly, global equities have moved close to records after the recent policy announcement by the Fed, although a number of commentators are still exhibiting a cautious bias and wonder if the bull market has run its course.
Political events have also assisted in supporting equity markets (keeping in mind that over the last few years investors have also lived through periods of negative sentiment towards risk assets):
- The US president had a meeting with China’s leader which lived up to (moderately) positive expectations.
- Trade negotiations between Mercosur and Europe are concluded paving the way for a trade boost between these regions;
- The U.S. and North Korea unexpectedly agreed to re-start nuclear negotiations.
Last month’s Investment Outlook stated that, although episodes of draw-downs and market jitters cannot be ruled out, structural economic trends are unlikely to disrupt the longer term outlook for the world economy. Global economic trends have been characterised by continued downward pressure on interest rates in western democracies and most central banks have been pursuing accommodative policies that go a long way to counter the potential negative effects of protectionist measures in a number of countries. Decreasing fixed income yields offer a strong tailwind to interest rate sensitive parts of the economy and the valuation of risk assets. In short, global equities continue to offer superior investment opportunities to most other asset classes and remain “the only game in town”.
Loose monetary policy is the new consensus
After the latest FED meeting it has become clear that US monetary authorities have moved fully towards an accommodative stance. As always a detailed analysis of statements by the Open Market Committee of the FED offers the clearest and most reliable source for assessing monetary policy. The Statement accompanying the June FED meeting states the following:
“…the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective”
It is noteworthy that, in comparisons to previous statements, any reference of the FED being “patient” has been removed and has been replaced by the phrase to “act as appropriate”. Also, the reference to “muted inflationary pressures” suggests that a rate cut has become a logical next step for FED policy makers. The only dissenting FOMC member, Bullard, stated after the meeting that “the forces that are keeping inflation below target seem unlikely to be solely transitory…Lowering the target range for the federal funds rate at this time would provide insurance against further declines”. It is important to note that the longer term median interest rate projection by FOMC members was reduced from 2.8% to 2.5%.
The FED policy stance had been attracting increased scrutiny, with an increasing number of commentators wondering what the appropriate monetary policy should be in a world where dis-inflationary pressures have been intensifying, and labour markets remain strong (thereby invalidating the basic notion of the traditional Phillips curve theory). After the recent FED meeting one can conclude, however, that the doves have “won the argument” and any discussion of policy normalisation now seems almost “out of date”. In judging the latest move by the FOMC it seems relevant to stress that there does not seem to be any immediate downside for the FED to cutting rates considering the low underlying inflation rates and downward pressure on inflationary expectations.
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