Investors can at least stop worrying about when the summer calm will end.
Sharp moves higher in bond yields from Japan to Germany last week have spilled into stock markets over the past two days. The S&P 500 lost 2.5 per cent on Friday in its biggest drop since the vote for Brexit in late June, while European equities finished Monday lower.
It was little surprise the disquiet began in fixed income, where a combination of low inflation in developed economies, stimulus from the European Central Bank and the Bank of Japan, as well as the surprise vote for Brexit turbocharged a rally that has left more than $13tn of bonds with negative yields.
The injection of volatility came from the central banks whose interventions have reshaped bond markets. Mario Draghi, the ECB president, disappointed investors by failing to announce an extension to its €80bn-a-month quantitative easing programme. Meanwhile, Haruhiko Kuroda, the governor of the Bank of Japan, will next week report the findings of a review of the effectiveness of the central bank’s own pioneering stimulus programme.
“Even just the smell of central bankers changing tack can create a tantrum,” said Alberto Gallo, head of macro strategies at Algebris, a credit hedge fund. “For the first time they’re questioning themselves.”
It is important to note that a couple of days’ volatile trading do not add up to a tantrum, the shorthand used to refer to the big sell-off in government bonds in 2013 after then US Federal Reserve chairman Ben Bernanke signalled the end of QE and last year’s squall in German Bunds.
There is some irony in the prospect of a recalibration of stimulus programmes unnerving investors, who have complained loudly this year that the latest chapter in QE programmes from the BoJ and the ECB — including the introduction of negative rates — has caused too much collateral damage, including to banks’ business models.
“It could be the beginning of a new paradigm, when you hear members of the ECB or the BOJ really clearly suggesting that flattening the yield curve might actually be counterproductive because it’s damaging so much the business model of banks,” says Didier Saint-Georges, managing director at Carmignac.
There is little doubt that investors are on edge in a way they haven’t been since fears over the global fallout from the Brexit vote dissipated in early July.
The next source of anxiety will come from the Fed, which has spent the past month trying to keep investors alive to the possibility that officials could raise interest rates when they meet next week.
“The degree of complacency and low volume over the summer — that environment is behind us,” said David Donabedian, chief investment officer at Atlantic Trust. “This is to some extent an appropriate response taking into account where monetary policy is headed and we are seeing a concerted public relations effort by [Federal Open Market Committee] members to get the market ready for a hike this year.”
Fed officials meet on September 21. Speculation that the Fed might raise rates was hit late on Monday when Lael Brainard, a voting policymaker, suggested the bank should act with caution.
The same day the Fed gives its decision, BoJ policymakers will give the results of their comprehensive assessment, which many expect will involve the bank indicating an unwillingness to further flatten the yield curve in Japan in a dynamic that hurts the profits of banks.
Even if markets are on the cusp of a period in which central banks recalibrate the stimulus that has buoyed bonds and stocks in recent years, there are other factors that weigh against a sustained sell-off.
Most striking, are the anaemic levels of growth and inflation in Japan and Europe. Inflation in the eurozone is expected to come in at 0.2 per cent this year, well short of the ECB’s 2 per cent target.
“You can’t blame markets for being jittery with yields this low, but there is reason to be sceptical that the sell-off will continue,” says Ruairi Hourihane, rates strategist at Bank of America Merrill Lynch. “In the eurozone, the parameters for QE have not changed and there are ongoing stimulus programmes elsewhere — plus economic data is still disappointing.”
The near-record low level of yields and lofty valuation of US stocks, in particular, leave investors in a tricky position.
“It’s difficult to find a way out here … you’ve got that period which could be quite tricky for the market, initially this repricing of the yield curve is of course painful for all markets,” says Mr Saint-Georges. “But it’s quite possible that … this movement might not go very far.
“The reason central banks sounds less dovish is not because the economy has recovered,” he adds. “It’s because [QE] has not worked.”
The next few days, though, will be an uncomfortable period for both bond and equity markets. From Tuesday, Fed rate-setters will enter their official period of purdah before they give their decision, leaving investors having to second-guess their interpretations of important retail sales and inflation figures due at the end of the week.
Keith Parker, global equity strategist at Barclays, highlighted the dependency of share prices on policy. “Although rates are likely to stay low for some time, investors should factor in the volatility and risk of loss for equities,” he said.