The Short View: It’s enough to scare anyone
The Short View: It’s enough to scare anyone
By Philip Coggan, Investment Editor
Published: June 5 2006 18:41 | Last updated: June 5
2006 18:41. Copyright by The Financial Times
Working out what has been worrying investors in recent weeks has not been an easy task. The idea of an inflation scare has not been borne out by the action of either government bond yields or gold.
A growth scare has seemed the more likely explanation, given the sell-off in growth-sensitive assets such as emerging markets and mining stocks. But Friday’s weak non-farm payroll numbers saw the Dow Jones Industrial Average fall just 12 points.
Perhaps the key to the market’s reaction was the expectation that the weak data would prompt the US Federal Reserve to leave interest rates on hold this month. For it seems to be the interaction of the economic data and the Fed’s reaction that is the source of the market’s concern.
Three factors seem to be in play. There is a new Fed chairman, which naturally increases uncertainty. Will Ben Bernanke want to prove his anti-inflationary credentials by raising rates? The US is close to the top of the rate cycle, which means the Fed’s actions are not as predictable as they have been over the last two years. And the Fed has indicated that it is studying the data, which by their nature tend to be very variable.
Tim Bond of Barclays Capital says the secret of investors concerns can be found in the bond market. One can break bond yields down into the “real” element and the portion that reflects inflation expectations. There has been virtually no correlation over the last three years between equity markets and the real yields.
Bond argues that this makes sense. Rising real yields should be a reflection of strong economic growth, and thus be good news for corporate profits, so the effect on equities should be neutral.
But over the past year, there has been a strong negative correlation between equity markets and inflation expectations, ie when expectations have risen, equities have fallen. That seems to be because higher inflation will force the Fed to raise interest rates, eventually hitting economic growth and thus corporate profits.
So the real problems for the market is a combination of an inflation scare leading to a rates scare and thus a growth scare; that subtle combination has made the markets difficult to read.
philip.coggan@ft.com
By Philip Coggan, Investment Editor
Published: June 5 2006 18:41 | Last updated: June 5
2006 18:41. Copyright by The Financial Times
Working out what has been worrying investors in recent weeks has not been an easy task. The idea of an inflation scare has not been borne out by the action of either government bond yields or gold.
A growth scare has seemed the more likely explanation, given the sell-off in growth-sensitive assets such as emerging markets and mining stocks. But Friday’s weak non-farm payroll numbers saw the Dow Jones Industrial Average fall just 12 points.
Perhaps the key to the market’s reaction was the expectation that the weak data would prompt the US Federal Reserve to leave interest rates on hold this month. For it seems to be the interaction of the economic data and the Fed’s reaction that is the source of the market’s concern.
Three factors seem to be in play. There is a new Fed chairman, which naturally increases uncertainty. Will Ben Bernanke want to prove his anti-inflationary credentials by raising rates? The US is close to the top of the rate cycle, which means the Fed’s actions are not as predictable as they have been over the last two years. And the Fed has indicated that it is studying the data, which by their nature tend to be very variable.
Tim Bond of Barclays Capital says the secret of investors concerns can be found in the bond market. One can break bond yields down into the “real” element and the portion that reflects inflation expectations. There has been virtually no correlation over the last three years between equity markets and the real yields.
Bond argues that this makes sense. Rising real yields should be a reflection of strong economic growth, and thus be good news for corporate profits, so the effect on equities should be neutral.
But over the past year, there has been a strong negative correlation between equity markets and inflation expectations, ie when expectations have risen, equities have fallen. That seems to be because higher inflation will force the Fed to raise interest rates, eventually hitting economic growth and thus corporate profits.
So the real problems for the market is a combination of an inflation scare leading to a rates scare and thus a growth scare; that subtle combination has made the markets difficult to read.
philip.coggan@ft.com
posted by Carlos T Mock at 8:58 AM
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