John Chatfeild-Roberts: Reading the smoke signals from central banks

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The global divergence in interest rate policies has been a continuing theme throughout the year. We have seen it all: anticipation of a rise in the US and UK, more stability in the eurozone and Japan as both peruse significant quantitative easing programmes, and falling rates elsewhere, including China. There has also been a decline in the rate of global economic growth, with less than 3 per cent estimated for the year as a whole, down from the 3.4 per cent recorded in 2014. The situation continues to evolve.

China reported GDP of 6.9 per cent for Q3, a smidge below the 7 per cent of the first half. In October, the People’s Bank of China cut base rates for the sixth time in 12 months by another quarter point to 4.35 per cent. It also introduced fiscal packages to boost demand for housing and cars. We believe the rate of growth in China that matters to most investors is lower than the headline figure and the actions taken by the PBOC suggest the Chinese themselves remain worried about the direction of travel.

Elsewhere, European Central Bank president Mario Draghi continues to voice concerns about deflationary pressures. He is considering further stimulus options, including increasing the magnitude of the current €60bn a month QE programme, extending it beyond the September 2016 target end date and even reducing eurozone rates further (deposit rates there are already negative). It could even be a combination of all three.

If the current positive but relatively anaemic growth rate is the best Europe can achieve with zero borrowing costs, a weak euro helping exports, oil prices that are significantly beneficial to manufacturers and consumers, plus a massive dollop of economic liquidity via QE, you wonder what new magic wand the ECB can wave to produce a better result.

Meanwhile, Bank of England governor Mark Carney and US Federal Reserve chair Janet Yellen delivered more flip-flop messages in October. Yellen’s concerns early in the month about the impact of the global slowdown on the US economy had vanished from the end-of-month rate meeting statement, while, here, Carney told the Daily Mail rate rises were a “possibility, not a certainty”.

In their endeavour to provide guidance these two central bankers run the risk of emulating the  Grand Old Duke of York, marching us up the hill and down again. They and their committees are responsible for setting rates for two of the world’s largest economies and so it is discomfiting just how often their approach is described as “dithering” by commentators. However complex the issues might be, policymakers should provide clarity and leadership.

The market reacts

Out of the policy fog and after a volatile three months, markets have drawn their own conclusions about the timing of the initial US rate rise and the possibility of stronger ECB intervention next year. The dollar is off its recent peak, bond yields have fallen, particularly in the eurozone, and equity markets in the developed world have recovered much of their losses incurred since August. Sentiment – an important, if indefinable, factor in all markets’ behaviour – remains fragile. We may yet see further evidence of the global economic headwinds blowing from China impacting corporate profits in some sectors and regions but at least the markets’ recent pall of gloom has lifted.

The next few weeks are potentially important for market watchers. The ECB meets on 3 December, when Draghi will reveal his plans for rebooting the eurozone economy.  Opec meets in Vienna on 4 December to discuss policy and production levels for 2016. By then, it will be around 18 months since the oil price began collapsing. Will Opec reduce output to boost prices or will it continue the long game favoured by Saudi Arabia, maintaining production at current levels and calculatedly trading volume for price, to tighten the competitive screw another turn? Either way, there are ramifications for medium-term global inflation prospects. The next Federal Reserve meeting is on 16 December. A rate rise remains possible before Christmas but in the absence of that the market will be trying to read the smoke signals.

At the time of writing, markets assign a 46 per cent probability to rates rising initially in December, 54 per cent to the decision being delayed to January and 70 per cent for March, according to Bloomberg. We reiterate our belief in the “lower for longer” scenario for interest rates but the trajectory should be gently upwards.

John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team