History will record last week as marking another record high in the S&P index for what, already, is one of the longest bull runs for US stocks.
What it won’t show, however, is that financial markets have become even more reliant on central banks whose ability to sustainably deliver on both economic and investor prosperity is being challenged by a growing set of ever more complex economic, geopolitical and policy factors. All this renders central banks more vulnerable to political attacks and possible interference with their highly prized operational autonomy.
Surging on the back of signs of additional liquidity stimulus from central banks, the S&P reached a new high on Thursday before a tiny easing on Friday. Stock investors were by no means the only ones having a good week.
Holders of fixed-income securities gained from both lower yields on government bonds and a narrowing of risk spreads in emerging markets and on investment-grade and high-yield debt. At the same time, gold reached a five-year high, oil erased all of its monthly price loss and, with a 3 per cent surge Friday alone, Bitcoins closed the week above the psychologically important price $10,000.
With the exception of oil, which was responding to Mideast tensions, a single factor was responsible for all the other moves in both risky and low-risk asset classes.
The Federal Reserve signalled willingness and ability to do more monetary stimulus. Markets rushed again to reprice lower the entire path for policy rates around most of the advanced world, and market chatter rose about the likelihood of looser central bank balance-sheet policies.
Considering the remunerative recent years of portfolio positioning on the basis of ample and predictable central bank liquidity, that signal alone was enough for markets to set aside what traditionally would be of concern on four distinct fronts.
News that President Donald Trump had called off almost at the last moment a military air strike against Iran added to concerns about escalating tension in the Middle East. Neither side is showing any intentions of defusing the tensions. Iran is raising the rhetoric while over the weekend, the US announced that it would tighten sanctions on Iran. These geopolitical tensions add to the political game of chess (and chicken) associated with trade dispute between China and the US.
Market hopes of a trade breakthrough at the G-20 in Japan have fallen as, ahead of direct talks between Trump and his Chinese counterpart, the US has blacklisted five additional Chinese entities.
All this comes in the context of new data showing economic weakness in the advanced world. This included poor factory data out of the US, which added to concerns about languishing manufacturing activity in Europe and Japan and increased the risk of a self-feeding contraction around the world.
All of which potentially amplifies the risks of the currently unbalanced policy mix in most of the advanced world.
Central banks’ feeling of being compelled to step in with further stimulus was in fact a reminder that other policymakers, with tools better suited to lift impediments to longer-term financial stability and high and inclusive growth, remain on the sideline. Neither the Bank of Japan, the ECB nor the Fed seems willing to see the currency appreciate at a time of economic fragility.
As such, the “race to the bottom” in terms of monetary stimulus is not a coordinated policy response, but seems more like a necessary evil.
Especially in view of their repeated conditioning by central banks, investors were right to celebrate last week signals of the major central banks’ continued willingness and ability to provide exceptional liquidity. But they would be wrong to lose sight of the underlying conditions and motivations. A good surfer can ride well a long and steady wave but also knows when to get off before it breaks.