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There’s little doubt that this outperformance across asset classes is the result of unprecedented monetary policy actions by the major central banks. The key question is what lies ahead on an economic and political level. Are central banks ready to pass on the stimulus torch to the governments and will fiscal policy become the new game in town – particularly now that governments issue their bonds at zero costs? Or will the central banks implement helicopter money policy by writing cheques directly to households and business? How will the emerging populism in major developed countries affect economic policies, international affairs and global trade?
Populism could potentially become the next black swan for developed economies and financial markets.
In our last quarterly outlook I wrote of the tug of war between politics and macroeconomics. Now, the rise and shift of populism in the politics of various developed countries raises a red flag. Populism could potentially become the next black swan for developed economies and financial markets. We’re already seeing it take hold in the United States, France, Italy, Germany, and Greece. While populism doesn’t present an imminent threat to capitalism, it does cast a large shadow over the prospects for globalisation and democratic values.
These political developments will likely set the stage for further fiscal interaction in the economic growth equation. With a number of programmes launched in Japan and China, we see even more prospects for the United Kingdom, France, Italy and the United States. Additional fiscal generosity opens even broader avenues for equities stimulated by growth – although less so for bonds, which are likely to be muted in their performance and look less attractive on a relative basis.
The coming quarter should remain a constructive environment for risky assets but we would look to get more cautious as the quarter develops.
The event that most caught my attention last quarter was Janet Yellen’s speech at Jackson Hole on the future path of monetary policy. Her speech reinforced the notions of ’new normal’ and ‘lower for longer’. According to Yellen “even if the average level of the federal funds rate in the future is only 3 per cent, the new tools (forward guidance and asset purchases) should be sufficient unless the recession were to be unusually severe and persistent.” In essence she was saying that, in future, interest rate changes will move in tighter ranges from peak to trough and will always be combined with asset purchases and forward guidance. This new normal of interest rates ranging 0-3per cent sets new standards for asset class valuations, cross asset correlations and volatility.
Taking all this into consideration, the coming quarter should remain a constructive environment for risky assets but we would look to get more cautious as the quarter develops due to a combination of steepening yield curves, rate hike in December in the US (a surprise would be a hike in the November meeting), political event risk (US elections in November, Italy constitutional referendum (expected November or December), and negative yields being seen for credit.
In the remainder of this report, the ideas and research we present reflect Dolfin’s investment philosophy and analytical methods. We approach financial markets by combining forward looking quantitative models with fundamental analysis and economic intuition.
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