Wednesday's Federal Open Market Committee outing saw the US central bank take a slightly more hawkish stance than was expected. Equities took only a minimal hit but the long-term impact on emerging markets could prove far more severe,
Article / 16 August 2016 at 9:00 GMT

Markets getting increasingly bubbly — will central bankers blink?

Head of FX Strategy / Saxo Bank
  • Central-bank stimulus pushes markets towards danger zone
  • Central banks likely getting increasingly edgy
  • Fed chair Janet Yellen could use Jackson Hole summit to rein in sentiment
  • Yellen's innate caution, nevertheless, legislates against a "reverse Bernanke"

Global asset markets are surging after central banks fuel easing sentiment. Photo: iStock

By John J Hardy

Global asset markets have surged over this summer of central-bank love, egged on by the Bank of England unleashing a fresh round of quantitative easing to absorb some of the shock of the Brexit vote. That vote failed to derail confidence in UK sovereign debt and UK stocks and global markets breathed a sigh of relief. 

Elsewhere, the world’s most important central bank, the US Federal Reserve, is largely seen as holding back from further interest rate hikes amid tepid US data. As for the European Central Bank, it loudly flagged a coming reassessment of its policy mix at the September 8 ECB meeting, heightening anticipation of even more easing on the way.

And in Japan, the Shinzo Abe government has promised a significant new front-loaded fiscal expansion, even as the government already ran the developed world’s largest budget deficit at near 7% of GDP before announcing the latest stimulus. The Bank of Japan is more than covering the government’s spending needs, of course, with a furious rate of asset purchases worth some 15% of GDP/year.

As I noted in my column a few weeks ago, this celebration of central bank liquidity as far as the eye can see means that global markets have regressed back to the upside down world in which bad data fires up anticipation of more liquidity provision from central banks and thus an ever upward spiral in asset prices.

Take the US S&P 500 Index, which has hit a string of record highs in August. That comes despite analysts downgrading forecasts for US large corporates for six quarters in a row and expectations for a 0.6% decline in Q3 earnings — the worst slump since the financial crisis. Then last Friday we got an ugly US Retail Sales report for July. Equities closed, of course, at a record high.

Central banks are playing a dangerous game in allowing asset prices to pull higher and higher when economic and earnings fundamentals aren’t supportive. What is more deflationary, after all, than the inevitable asset-market correction that dents confidence and destroys wealth, even if it is paper wealth?

And given the increasingly remarkable contrast between fundamentals and the markets, the question begs: at what point is the market’s assumption that the Fed is entirely blind to over-heated asset-market developments a dangerous one? It has, after all, been a safe bet ever since Alan Greenspan’s “irrational exuberance” speech of 1996 that caused a notable, if brief, mishap in US equities back in 1996.

Cue the Federal Reserve’s annual symposium held in Jackson Hole, Wyoming. It’s the ultimate gathering of the world’s central bankers, who get to rub shoulders and talk policy.

This year, Fed Chair Janet Yellen will be in attendance and will speak on August 26. Could she choose this moment to send a hint, no matter how subtle, that the Fed does not approve of global meltup in risky assets?

It would be ironic as it was on that very day in 2010 that then Fed chairman Ben Bernanke chose to pre-announce the Fed’s QE2 policy in a Jackson Hole speech that sent global markets ripping higher and crushed the US dollar. Look out below for asset markets, particularly white-hot emerging markets and their currencies and look out for USD strength if Yellen blinks and does a reverse Bernanke. All the same, don’t get your hopes up that she will.

Central banks must fear the "irrational exuberance" that is
leading markets towards a global meltup, but will they actually
something about it before it becomes dangerous? Photo: iStock

— Edited by Martin O'Rourke

John J Hardy is Saxo Bank's head of forex strategy


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