Well, was that it? The post ‘QE infinity’ rally seems to be consolidating already a mere two weeks after the big event. In reality though, this isn’t altogether surprising. As we discussed at the recent quarterly meeting the move from central banks acting in a reactive, to a proactive manner, and pledging to ‘do what it takes’ has reduced the tail risk scenarios. We reduced the probability of ‘crisis’ and ‘above trend growth to 5%, whilst increasing our ‘sub trend’ recovery base case to 80% leaving a 10% weight on the ‘recession’ scenario. Essentially, this puts the market focus back to where it was at the turn of the year and attempting to read the tea leaves around two key issues: the growth outlook and the Eurozone.
The growth outlook does look worrying, just as it has many times this year. Our proprietary lead indicators point to a very pedestrian growth profile and the anecdotal evidence from credit analysts suggests increased nervousness from company management teams. Recent rhetoric, and actions, from central banks, however, reinforces that they are alert to downside risks and stand ready to provide more monetary policy accommodation.
Looking at the other pillar of worry, the Eurozone, there’s no cogent message from the tea leaves. We’re back to trying to decipher summit communiqués as well as conflicting and competing versions of events from national policymakers. The focus now is on the implementation risk. When will the fiscal compact be implemented? When will the plans for a banking union be advanced? And above all, when will the weaker Eurozone countries move to request ECB assistance? The tea leaves are sadly unclear on all of these.
For fixed income markets this means a renewed focus on policymaker action (and inaction) which will fuel the usual risk on: risk off cycle and in turn create opportunity. With the central bank put option in play, interest rates on hold for longer, cash cascading into bond funds, we’re also inclined to look to buy corrections in risk assets.