18 Sept 2012
German ruling also boosts risk assets Market movements There were a number of policy events in September which have the potential to affect asset returns over the next three to six months. The European Central Bank (ECB) and US Federal Reserve (Fed) have both taken aggressive policy steps over last 10 days. Last week it was the Fed’s turn as it started its third round of its quantitative easing (QE3). This led to a strong rise in risk assets and also a strong rise in government bond yields last Friday. The US economy continues to slow during what has already been its most sluggish economic recovery in last six years. The upcoming Bank of Japan meeting is drawing interest because it is likely that it will also engage in a form of quantitative easing. The yen fell last Friday in reaction to this, but a sustained fall in the Japanese currency would help ignite a sustained equity rally. Fed action pleases markets The Fed’s pledge was pleasing for markets. Ben Bernanke, the Fed’s Chairman, said the US central bank would purchase $40 billion-worth of mortgage backed securities per month. This is similar to the action it took during the first round of quantitative easing when it focused on government bonds. In addition, the Fed said interest rates would be kept at low levels until at least 2015, although this was already priced into markets. The surprises came in the open-ended nature of the commitments from the Fed. This led to a positive move in the price of risk assets and in gold, while there was a sell-off in Treasuries and the US dollar. Markets have priced in the tolerance of higher inflation by the Fed as it focuses on trying to stimulate the economy. Bernanke highlighted weakness of the labour market explicitly in his announcement, stating that that there needs to be on-going and sustained recruitment. The chairman has made it clear that the Fed will be very active in its efforts to try and generate a sustainable recovery in the US economy. In effect, the Fed has put the inflation targeting part of its mandate on hold for the time being.
German ruling also boosts risk assets Risk assets and precious metals reacted positively to the news. It was a similar reaction during previous quantitative easing announcements. It is clear that while central bank asset purchases do not affect long term fundamentals, they do have a positive effect on the confidence of in consumer and corporate sectors. The other event last week was a ruling from the German Constitutional Court allowing the European Stability Mechanism (ESM) to proceed. Last week, global equities rallied 2%, with Sweden, Russia, Brazil and India all rising over 4%. Cyclical parts of global equity markets led the rises. Investors see recent monetary policy action as reducing risk premiums associated with sectors such as banking and mining. Currencies On currency markets, the euro currency was boosted by recent positive developments surrounding the eurozone debt crisis and the US Federal Reserve’s decision to launch a fresh round of quantitative easing. Over the course of the week, the euro rose above 1.30 to reach its highest level against the dollar in more than four months. The €/$ rate ended the week at €1.31, a strengthening of 2.6%. Oil & Commodities Commodities rallied to multi-month highs last week after receiving a boost from the US Federal Reserve’s decision to launch further stimulus. The West Texas oil price ended the week at $99 a barrel, 2.7% higher. Elsewhere, gold prices jumped to a six-month peak of $1,773 a troy ounce, a gain of over 2%. Elsewhere, silver, platinum and palladium also gained. Bonds Bond markets fell back last week as equity and commodity markets rallied. Italy and Spain’s cost of borrowing has declined since the ECB unveiled its plan to buy unlimited amounts of short-term debt. Italy easily raised €6.5 billion in three bond auctions and the yield on its 10year government bond fell to 5% for the first time since March. The Merrill Lynch over 5 year government bond index ended the week 0.5% lower. Source: Zurich Investment Managers, Aviva Investment Managers, FT.com, Blackrock & Bloomberg