Financial Times Editorial - In turbulent times
Financial Times Editorial - In turbulent times
Published: May 18 2006 03:00 | Last updated: May 18 2006 03:00. Copyright by The Financial Times
Fasten your seatbelts: we are encountering some unexpected turbulence. After a long period of almost unnatural calm, volatility has returned across a wide range of asset classes. After stormy sessions on Thursday, Friday and Monday, markets bounced back on Tuesday, only for US inflation data to provoke further falls in stocks and bonds on Wednesday. The only safe assumption is that there will be more volatility to come.
It is not easy to find a single common factor that explains the recent movements in equities, bonds, currencies and commodities. Rather, the increased volatility reflects the coming together of several different factors, including heightened fear of inflation, a rise in long-term global real interest rates and renewed concern about the US trade deficit and the dollar.
At the start of the year, the break-even inflation rate on 10-year US inflation-protected Treasury bonds was 2.34 per cent. On Friday the break-even rate hit 2.74 per cent. The markets are jittery about Ben Bernanke, the new Federal Reserve chairman. These fears are overdone but at this stage of the cycle the Fed is no longer able to give clear guidance on interest rates.
Real interest rates are on the rise too, driven by strengthening activity in Japan and, to a lesser extent, the eurozone. As a result, the yield on 10-year US Treasuries has risen from 4.4 per cent at the beginning of the year to a peak of 5.21 per cent on Friday. This has undermined one of the strongest arguments for buying equities: that they were cheap relative to bonds.
Meanwhile the US dollar appears to be once again on a secular downward trend, driven by concerns over the record US trade deficit. Since the beginning of April it has lost nearly 4 per cent of its value on a trade-weighted basis, and is now trading at levels last seen in October 1997. The increasingly broad-based nature of the decline, with falls against the yen and even slight declines against the Chinese renminbi, suggest it may be able to continue further than in the past.
Inflation fears, rising real rates and concerns over the dollar are being reinforced by the gradual withdrawal of liquidity by central banks and the slow-motion end of the carry trade (borrowing in currencies with low interest rates). These need not spell the end of the equity bull market. Shares are only a fraction down from their recent highs. Valuations remain moderate in recent historic terms, though not when cyclically adjusted.
But there is no denying that the broad environment for stocks is less favourable than it was a year ago. And with risk premia still very low by historic standards, low rated bonds and emerging market assets remain at risk of a much bigger correction in the future. At the very least, the experience of the past few days is a salutary reminder that downside risks must be taken very seriously
Published: May 18 2006 03:00 | Last updated: May 18 2006 03:00. Copyright by The Financial Times
Fasten your seatbelts: we are encountering some unexpected turbulence. After a long period of almost unnatural calm, volatility has returned across a wide range of asset classes. After stormy sessions on Thursday, Friday and Monday, markets bounced back on Tuesday, only for US inflation data to provoke further falls in stocks and bonds on Wednesday. The only safe assumption is that there will be more volatility to come.
It is not easy to find a single common factor that explains the recent movements in equities, bonds, currencies and commodities. Rather, the increased volatility reflects the coming together of several different factors, including heightened fear of inflation, a rise in long-term global real interest rates and renewed concern about the US trade deficit and the dollar.
At the start of the year, the break-even inflation rate on 10-year US inflation-protected Treasury bonds was 2.34 per cent. On Friday the break-even rate hit 2.74 per cent. The markets are jittery about Ben Bernanke, the new Federal Reserve chairman. These fears are overdone but at this stage of the cycle the Fed is no longer able to give clear guidance on interest rates.
Real interest rates are on the rise too, driven by strengthening activity in Japan and, to a lesser extent, the eurozone. As a result, the yield on 10-year US Treasuries has risen from 4.4 per cent at the beginning of the year to a peak of 5.21 per cent on Friday. This has undermined one of the strongest arguments for buying equities: that they were cheap relative to bonds.
Meanwhile the US dollar appears to be once again on a secular downward trend, driven by concerns over the record US trade deficit. Since the beginning of April it has lost nearly 4 per cent of its value on a trade-weighted basis, and is now trading at levels last seen in October 1997. The increasingly broad-based nature of the decline, with falls against the yen and even slight declines against the Chinese renminbi, suggest it may be able to continue further than in the past.
Inflation fears, rising real rates and concerns over the dollar are being reinforced by the gradual withdrawal of liquidity by central banks and the slow-motion end of the carry trade (borrowing in currencies with low interest rates). These need not spell the end of the equity bull market. Shares are only a fraction down from their recent highs. Valuations remain moderate in recent historic terms, though not when cyclically adjusted.
But there is no denying that the broad environment for stocks is less favourable than it was a year ago. And with risk premia still very low by historic standards, low rated bonds and emerging market assets remain at risk of a much bigger correction in the future. At the very least, the experience of the past few days is a salutary reminder that downside risks must be taken very seriously
posted by Carlos T Mock at 10:25 AM
0 Comments:
Post a Comment
<< Home