Monetary Policy Takes Center Stage
By Percival Stanion, Chairman, Strategic Policy Group'
Baring Asset Management (Barings), London
(Barings is the Subadviser to the ASTON/Barings International Fund)
It seems clear that the Federal Reserve’s stance on reducing its bond-buying program is likely to continue to dominate markets over the next few months. The shock of May’s rapid decline in global bond markets and sharp increases in mortgage rates was a lesson that any reduction in bond buying will have to be carefully managed. The Federal Reserve has been airing the possibility of altering its forward guidance either by adjusting the unemployment rate threshold at which it may consider less accommodative monetary policy or by attaching an explicit inflation condition. In addition, there is the possibility the Fed may take the interest it pays on bank reserves to a negative rate to force banks to recirculate their reserves into the financial markets and keep short rates down. Only time will tell which of these policies will work. The whole debate also shows how tricky it is to exit such a policy as bond buying in the U.S.
The UK did manage to end its own program without any obvious side effects, but we suspect this was because the program here was fundamentally flawed in the first place and not actually contributing much to an actual loosening of monetary conditions. The Bank of England now has an equally difficult task ahead of it to maintain credibility in monetary policy, with markets already expecting a much earlier cut in interest rates than the bank had indicated only a few weeks ago.
We suspect that the recent upgrade to the Bank of England growth forecast was carried out to give room for disappointment the next two years—allowing the opportunity to postpone any rate rises for an extended period without losing too much credibility. In Europe, European Central Bank president Mario Draghi has the even more difficult task of boosting support for stimulative measures. The rate cut pushed through in the face of German opposition could only be done with the stark evidence of deepening deflationary pressures. Meanwhile, German Chancellor Merkel has still not managed to form a grand coalition with the opposition Social Democratic Party (SPD), which could weaken her position ahead of the next EU summit on December 19. We believe her continuing support for Mr. Draghi means that his policy stance will be more accommodative than the Germans want, though unfortunately we think probably not easy enough to allow a full European recovery. There has been no change in monetary policy in Japan in recent weeks. We are watching the winter bonus season to see whether Japanese firms will redistribute corporate profits to help sustain the increase in consumer demand.
In terms of asset positioning, we have become more cautious towards government bonds along with index-linked bonds and investment grade credit. After a brief and rather feeble rally, we think that government bonds are likely to be under continuous pressure as the bond buying debate grinds on. In the long-term, we believe that they are very poor value and at some point are vulnerable to a rise in yields towards the 5% level. Spreads for investment grade bonds are also inadequate. We still take a neutral view on high yield due to the large spreads and the declining default rate at this stage in the economic cycle.
We have not altered our neutral view on equities and major markets generally, though we remain more positive on the outlook for Japan. We have become more optimistic on the Industrials sector, which we think will provide more exposure to further improvements in economic growth. Equities are finding it more difficult to make headway after the sharp rises of the last year and the modest outlook for profit growth. We still believe that equities present the best opportunity in this phase in the cycle and expect to upgrade our rating at some point in the next few months once the policy uncertainty clears up.
The information contained in this article is provided by Baring Asset Management (“Barings”), a subadviser engaged by Aston Asset Management, LP (“Aston”). Barings is not an affiliate of Aston and their views do not necessarily reflect those of Aston.
This material is not intended to be a forecast of future events, does not constitute investment advice, and is not intended as a recommendation to buy or sell any security. Investors should consult their investment professional regarding their individual investment program. Since the date of this report, economic factors, market conditions and Barings’ views of the prospects of any particular investment may have changed. Investors should consider the investment objectives, risks and associated costs carefully before investing. Forward-looking information is subject to certain risk, trends, and uncertainties that could cause actual results to differ materially from those predicted. Past performance is no guarantee of future results.