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Market mayhem: is the worst over?

After a dire start to the year, markets have shown signs of recovery. Tonight's statement by the Federal Reserve could hold the key.

 

by Daniel Grote on Jan 27, 2016 at 16:24

Market mayhem: is the worst over?

After a dire start to the year, stock markets have finally started to show some signs of regaining their footing. Since tumbling into a bear market last week as fears over China's slowing growth and the tumbling oil price took their toll, the FTSE 100 has mounted a steady recovery, and is up 4.8% over the last five days.

So what has changed? The rebound can largely be attributed to just a few words uttered by European Central Bank president Mario Draghi, and Khalid al-Falih, chairman of Saudi Arabia's state oil company.

Draghi's pledge last week that the bank would 'review and possibly reconsider our monetary policy stance at our next meeting in early March' provided just the tonic that beaten-up markets needed. The prospect of more quantitative easing (QE), or money printing, in the eurozone helped to lift the FTSE 100 out of bear market territory and sent global indices rallying.

Markets were given the next leg up the following day, when al-Falih claimed oil's descent below the $30 a barrel mark was 'irrational'. That sent the price of crude soaring, taking markets with it.

Does the sudden injection of relief into markets provide a sign that the worse may be over for investors? Not so, according to Guy Stephens, managing director of wealth managers Rowan Dartington, who labelled the reaction to Draghi's comments 'irrational'.

'For some reason the markets interpreted the potential to print yet more money in Europe as a good reason to temporarily stop worrying about oil prices, commodities, emerging market debt and China,' he said.

John Chatfeild-Roberts, manager of the Jupiter Merlin range of multi-manager funds, agreed Draghi's words did not merit the rally they sparked. 'If such comments can trigger sudden price moves it tells you that markets are acting more on feelings than facts,' he said.

'Nothing has changed'

And just as sentiment turned quickly at the end of last week, so it can turn again. 'Whilst the bounce in markets provided welcome relief, nothing has fundamentally changed,' said Stephens.

'There is a strong chance that the situation will continue to intensify and that we could revisit the recent lows as the reality of excess oil supply overwhelms political rhetoric from Draghi and Saudi Arabia.'

But Dominic Rossi, chief investment officer at fund group Fidelity, argued the impact of central bankers on the direction of markets should not be downplayed, adding the tone struck by the US Federal Reserve tonight in its first statement since raising rates last year would be crucial.

He argued that part of the blame for the problems facing markets could be laid at the door of the world's major central banks, and their communication of changes towards the end of last year.

The ECB last month sent markets tumbling after Draghi's botched extension of quantitative easing underwhelmed investors, while the People's Bank of China (PBOC) switching its 'reference rate' for the yuan from the dollar to a basket of currencies last December also sparked jitters.

Draghi's comments last week amounted to an admission his QE extension had not worked, while the PBOC has also sought to calm investors fearful over foreign exchange moves.

Fed holds key

Now it is the job for the Fed to make amends for its mistakes, according to Rossi. 'The Fed, while managing the actual increase in the federal funds rate quite well, made a communication error when it was quite forceful in stressing the difference between its forecast for interest rates and the market's, which was substantially lower,' he said.

'The Fed has consistently miscalculated the effects of its statements on the foreign exchange markets,' he added, arguing the rally in the dollar this had sparked had helped to push beaten-up commodities and emerging markets yet lower.

The Fed's projections alongside its December interest rate rise implied up to four 0.25% hikes this year, but the central bank now needed to row back from that in order not to dampen global demand, said Rossi. US consumers now needed to be encouraged to use the extra dollars in their pocket from the oil price plunge to fill the spending gap left by the slump in developing world demand, and they needed all the help they could get, he added.

'Oil's fall is clearly going to boost real incomes across the developing world. As we move into the US the big question is whether or not the US consumer will spend this additional real income,' said Rossi.

'We need the US consumer to offset the fall in demand that is arising from the emerging markets crisis. The evidence going back to the 1980s is that the consumer does not instantly spend this windfall - they wait to see whether it is a permanent one or not.

'While we work through this conundrum, it is very important that the world's central banks communicate very clearly an accommodative approach to monetary policy that will sustain aggregate demand over the developed world.'

3 comments so far. Why not have your say?

JohnR

Jan 27, 2016 at 18:28

What sort of market is it, really, that relies on the words of a global crime syndicate?

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Pat Murphy

Jan 27, 2016 at 19:14

Singular syndicate?....Russians, OPEC, Chinese, Mafia, Hedge Funds, Bankers etc.

But was it ever so?

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Pilgrim

Jan 31, 2016 at 17:17

Other factors to think about too.

Looks suspiciously like UKIP and friends may be getting a little more than they bargained for! Is this the start of capital flight from the UK, a currency speculation paradise?

It isn't clear for whose benefit the BoE and Osborne's bunch in the Treasury are meant to be operating, but it is certainly not for the benefit of any British business trying to do business abroad.

For about the past 8-10 weeks the value of the pound sterling has been dropping by about 1% per week against the euro, and by almost as much against the USD.

In principle, a fall in the value of sterling should make Britain more attractive to our major clients in the Euro-zone, which it does sometimes. But the problem is that with wild swings in relative value, the currency risk provides a strong disincentive to true free trading relationships between Britain and the rest of Europe. Customers in Europe have the choice between gambling on currency values, or paying for a currency hedge, or buying risk free elsewhere in Europe.

If it is talk of Brexit that is causing flight, we are promised a drip feed of the torture set to last for many months ahead.

Could be a good time for companies exporting goods and services to Europe, but a very tough time for importers, having to pay ever higher prices in sterling for imported goods. With Europe a major source of our food, it may be imagined that food prices in the shops may have to rise. i.e. food price inflation must be on the menu?

The Swedish Kronor is another European currency outside the Euro zone. Sweden is also very closely dependent on trade with the rest of Europe. Plotting out variations of the pound and the SEK against the Euro, it can be seen that while the SEK has been kept within a band of +/- 2% for the past year, the pound has been much more volatile and is barely contained within an excursion bandwidth of 9%.

How does Sweden succeed in managing its currency so much better than we do?

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