Markets getting increasingly bubbly – will central bankers blink?

2016-08-18

Markets getting increasingly bubbly – will central bankers blink?

Global asset markets have surged over this summer of central bank love, egged on by the Bank of England unleashing a fresh round of quantitative easing to absorb some of the shock of the Brexit vote. That vote failed to derail confidence in UK sovereign debt and UK stocks and global markets breathed a sigh of relief. Elsewhere, the world’s most important central bank, the US Federal Reserve, is largely seen as holding back from further interest rate hikes amid tepid US data. As for the ECB, it loudly flagged a coming reassessment of its policy mix at the September 8 ECB meeting, heightening anticipation of even more easing on the way.

And in Japan, the Abe government has promised a significant new front-loaded fiscal expansion, even as the government already ran the developed world’s largest budget deficit at near 7% of GDP before announcing the latest stimulus. The Bank of Japan is more than covering the government’s spending needs, of course, with a furious rate of asset purchase worth some 15% of GDP per year.

As I noted in my column from a few weeks ago, this celebration of central bank liquidity as far as the eye can see means that global markets have regressed back to the upside down world in which bad data fires up anticipation of more liquidity provision from central banks and thus an ever upward spiral in asset prices. Take the US S&P 500 Index, which has hit a string of record highs in August. That comes despite analysts downgrading forecasts for US large corporates for six quarters in a row and expectations for a -0.6% decline in Q3 earnings – the worst slump since the financial crisis. Then last Friday we got an ugly US Retail Sales report for July. Equities closed, of course, at a record high.

Central banks are playing a dangerous game in allowing asset prices to pull higher and higher when economic and earnings fundamentals aren’t supportive. What is more deflationary, after all, than the inevitable asset market correction that dents confidence and destroys wealth, even if it is paper wealth?

And given the increasingly remarkable contrast between fundamentals and the markets, the question begs: at what point is the market’s assumption that the Fed is entirely blind to over-heated asset market developments a dangerous one? It has, after all, been a safe bet ever since Greenspan’s “irrational exuberance” speech of 1996 that caused a notable, if brief, mishap in US equities back in 1996.

Cue the Federal Reserve’s annual symposium held in Jackson Hole, Wyoming. It’s the ultimate gathering of the world’s central bankers, who get to rub shoulders and talk policy. This year, Fed Chair Janet Yellen will be in attendance and will speak on August 26th. Could she choose this moment to send a hint, no matter how subtle, that the Fed does not approve of global melt-up in risky assets? It would be ironic as it was on that very day in 2010 that then Fed Chairman Bernanke chose to pre-announce the Fed’s QE2 policy in a Jackson Hole speech that send global markets ripping higher and crushed the US dollar. Look out below for asset markets, particularly white hot emerging markets and their currencies and look out for USD strength if Yellen blinks and does a reverse Bernanke. All the same, don’t get your hopes up that she will.

Source: John J. Hardy, Saxo Bank

Source from : Stock News

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