Protectionist tendencies right through to a trade war, exit movement after elections in Europe, geopolitical crises: a year ago, many economists were fearing a whole host of bad news and were anxiously braced for the worst. However, the global economy and the international financial markets in fact began 2017 in a markedly different tone to twelve months earlier, with no bangs and crashes whatsoever. Instead, the global economic and stock market concerto continued neatly in the same key in which it finished the previous year.
The familiar melody of US recovery played on almost uninterrupted – and actually with even stronger accents following Donald Trump’s election victory. The major notes in Europe’s basic tenor also still sounded very harmonious, albeit somewhat more muted due to the stifling effect of upcoming elections with dangerous potential for a rupture. Finally, in the Asian part of the intercontinental trio, despite a number of critical interjections, the most dominant voices were China with its crescendoing growth motive and – perhaps rather more piano – Japan.
All in all, there was so much pleasing music to investors’ ears that some wrong notes were almost ignored. The hullabaloo surrounding various political factors with the potential to disrupt the economy and the markets died down surprisingly smoothly and entirely without fanfare. The European anthem “Ode to Joy” has been reverberating most remarkably around the old continent since the pro-EU election result in France. There is no longer any audible background hum, either from an EU leadership crisis or from the debt and banking crisis. People even appear to have got used to the noises about the US administration’s protectionist tendencies or a trade war, which recur every few beats, and to the frequent din regarding the conflicts in North Korea and the Middle East... So what could actually still unsettle the world of investors and shake their faith in their guiding principle “Don’t worry, be happy”?
Let’s not kid ourselves: this is essentially a variation on the classic work orchestrated masterfully on dozens of occasions by former US Federal Reserve chiefs Alan Greenspan and Ben Bernanke. The monetary policy compositions of current incumbent Janet Yellen, just like those of ECB President Mario Draghi and BoJ Governor Haruhiko Kuroda, adhere much more precisely to the exuberant theory of harmony whereby the market is to be lulled immediately with magic words and extremely accommodative liquidity whenever any upheaval threatens to disturb its balanced rhythm.
This lighter note is also consistent with at least one puzzlingly strange and persistently jarring chord that has been impossible to ignore for more than a decade now: the conundrum of excessively low long-term interest rates. They are an echo of the extreme monetary policy still being pursued ceaselessly on bond markets around the world.
But what happens when the world-famous conductors all one day retire from the monetary policy stage in quick succession? Isn’t dissonance – due to the ignorance of the doctrinal roots and practical experience of (some of) their successors – simply an inevitable consequence?
Despite all the frenetic applause that the current central bank governors have received for their exalted hymn to monetary flexibility in the financial world, their status should not be elevated to mythical heights. The performance of the real economy – and in particular market music as the second voice complementing the fundamental melody – has never been and never will be a work that can be precisely orchestrated, but often features sections of spontaneous improvisation. Even the most brilliant central bank conductors cannot compose economic live concerts artificially in the policy rate studio. Of course, Yellen and Draghi in particular – and this is what both players and interprets on the trading floor will probably come to miss most in the near future – were maestros in the art of preparing the markets for future monetary policy measures with their fabled forward guidance.
The music on the capital markets should not fall completely silent even without Yellen, Draghi and Kuroda, therefore, but its dynamic and timbre could be rather chaotic for a short cadence. During the initial learning phase in particular, a few wrong notes are only to be expected: until the financial and economic ensemble and the new Fed, ECB and BoJ conductors have settled into their roles; until it is clear whether and which of them will revert to the traditional style of sound money and credit or will even have to beat out the monetary rhythm according to strictly prescribed notes such as an inflation target. The markets’ repertoire is not unlimited, however – they often perform reprises or modern remakes of well-known themes. For example, asset managers currently require especially finely-tuned senses to identify contemporary variations in the “music of the future” before the majority of the investing audience. It will be to our advantage to prepare ourselves for a few major drumbeats.
Dr Alex Durrer
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