One of the most commonly held beliefs is that markets don’t like uncertainty. Not only is this statement particularly dubious in light of the fact that uncertainty is the very essence of markets, but it is quite simply wrong nowadays, at least where inflation and growth are concerned.
Central banks have been pursuing accommodative monetary policies (negative interest rates, quantitative easing) on an unprecedented scale for nearly a decade. The overriding concern has been to prevent the world from sliding into deflation by tumbling into a spiral of falling prices, consumer spending and investment, followed by a deep recession.
When these policies were first implemented in the United States in 2009, many economists feared that it would be very hard to strike the right balance, and that in seeking to combat the threat of deflation by pumping billions of dollars of cash into the economy, central banks were actually running the risk of causing an uncontrolled inflationary spurt at some point.
This has yet to happen.
The fight against deflation was never really won, though, and the outcome remains uncertain.
Central banks have certainly been close to success of late, as the US economy is nearing full employment and conditions are now perfect for a wider recovery in the Eurozone.
This has allowed the Federal Reserve to bring an end to its famed quantitative easing in 2014 and start raising its key interest rates in December 2015. The European Central Bank is not quite there yet, but has already announced that it will start tapering its own QE in the next six months or so. A hike in interest rates could then follow.
There are many reasons why central banks would like to extricate themselves from this unorthodox monetary policy as soon as possible: to restore some leeway for when the economy weakens again; to reduce the financial asset price distortions caused by this policy over many years; and to avoid having to normalise interest rates too hastily when inflation really does pick up.
But this year, they are still afraid of acting too soon and too strongly. This is because raising interest rates when inflation is still not out of the danger zone – i.e. below 2 per cent – and economies remain fragile could potentially harm recovery and revive the threat of inflation dropping back down.
Despite strong job creation in the United States, wage growth is minimal because the positions created are mostly unskilled, and above all because companies remain very careful about controlling costs. Oil prices continue to trade at very modest levels, even after rallying in 2016. In addition, the eagerness of over-indebted US consumers to spend money is starting to fade, and recent figures on rises in house and vehicle prices came in below forecast. Some leading US indicators are starting to turn around, so nothing is guaranteed.
But this continued uncertainty is actually a blessing for the markets, as it leads the central banks to keep a cautious stance, which is the ideal scenario for investors. Should inflation start to clearly pick up, the central banks would be forced to take action, and the markets would inevitably have to factor in a rate hike, raising serious questions about financial asset prices. If, on the other hand, growth and inflation rates were to fall again after all, this would mean the ultimate failure of years of central bank intervention, which would come as a massive disappointment to equity investors. Once markets can be certain about the direction inflation will take, be it up or down, they will have good reason to worry.
In the meantime, they can enjoy the current air of uncertainty.
Didier Saint-Georges is managing director and member of the investment committee at Carmignac