{"id":66864,"date":"2017-11-09T07:16:38","date_gmt":"2017-11-09T06:16:38","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/the-end-of-accomodative-policies-a-new-challenge-for-asset-managers\/"},"modified":"2019-12-31T02:16:04","modified_gmt":"2019-12-31T01:16:04","slug":"the-end-of-accomodative-policies-a-new-challenge-for-asset-managers","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/the-end-of-accomodative-policies-a-new-challenge-for-asset-managers\/","title":{"rendered":"The end of accomodative policies, a new challenge for asset managers"},"content":{"rendered":"

The 2008 crisis caused a major shock for all
\ndeveloped and emerging economies. However,
\nthe stock market crash of 1929 – comparable
\nin scope and nature \u2013 provided valuable
\nexperience and insight: fast and massive
\nintervention from governments and central
\nbanks helped to avert the worst.<\/p>\n

After bringing key rates down in all developed
\ncountries, central banks set exceptional
\nmonetary policy<\/strong> actions into motion. Stepping
\nway beyond their traditional role as a lender
\nof last resort, they flooded capital markets
\nwith liquidity, using increasingly daring
\nmechanisms, before deploying asset purchase
\nprogrammes in most countries. The volumes
\ninvolved were unheard of: central banks
\nowned over 20% of GDP in the U.S., over 30%
\nin the Eurozone, and over 90% in Japan (of
\nwhich a significant amount in ETFs).<\/p>\n

Furthermore, the way central banks
\ncommunicate<\/strong> evolved, as they moved
\ntowards \u201cforward guidance\u201d, providing
\ninformation on the upcoming policy as early as
\npossible, at least in broad terms even if details
\ncannot be disclosed.<\/p>\n

This largely contributed to stabilising shortterm,
\nand therefore long-term, rate forecasts.
\nHowever the most successful form of
\ncommunication came from Mr Draghi,
\nChairman of the ECB, when he publically
\nstated that he would do \u201cwhatever it takes\u201d to
\nsave the Eurozone, and probably did in the
\nprocess. <\/p>\n

Central bank communication is now
\nscrutinised in its finest detail – every six weeks
\nwhen the scheduled meetings take place, but
\nalso whenever one of the members makes a
\nstatement. <\/p>\n

\"central_bank_balance_sheet.jpg\"<\/a><\/p>\n

The end of these extraordinary monetary
\npolicy measures is now in sight, with the
\ndisappearance of deflationary risks. However
\ninflation<\/strong> has still not returned – \u201ca mystery\u201d to
\nquote Janet Yellen. Is the technological
\ndisruption, which is driving long-term changes
\nin consumer behaviour, causing durable
\ndisruption to inflation models? More recently,
\ntimid wage growth has continued to raise
\nquestions, considering the current stage of the
\ncycle.<\/p>\n

To decipher this lack of inflationary pressure,
\nit will be important to make a clear distinction
\nbetween structural (demographic for instance)
\nand environment-related factors (such as the
\nreturn of long-term unemployment).<\/p>\n

We firmly believe that the environmentrelated
\nfactors will wane, enabling inflation to
\nrise beyond 2%, even if structural factors
\nmean that the scenario of run-away inflation
\ncannot materialise. <\/p>\n

The fact remains that central banks will not
\nwait until their inflation targets are reached
\nbefore they start to normalise monetary policy.
\nIn this respect, the Federal Reserve has
\nalready, very gradually, upped its interest rate
\nand has started not to reinvest some of the
\nproceeds from maturing bonds. The ECB is
\nplanning to make further cuts to the volume
\nof asset purchases in 2018.<\/p>\n

\"unemployment_rates_and_wage_in_the_usa.jpg\"<\/a><\/p>\n

The presence of central banks across the
\nentire yield curve, but also in the corporate
\nbond market, has disrupted the normal
\nrunning of capital markets. <\/p>\n

Volatility<\/strong> collapsed in the corporate bond
\nmarket; this made sense, but also indirectly
\naffected the equity market. Furthermore,
\nthese low volatility levels stem from the huge
\nsector dispersion observed across markets today. This is particularly true in the United
\nStates, where technology and real estate
\nstocks have rallied by over 30% in 12 months
\nand have more than offset the losses posted
\nby the energy or food retail industries (-20%).
\nVolatility then spread to currencies, a perfect
\nexample of which would be the exceptional
\nperformance of the dollar in recent weeks.
\nInvestors will also need to keep a close watch
\non credit valuations as several records have
\nbeen broken: last summer, several high yield
\ncorporate bonds in the Eurozone yielded less
\nthan 10-year U.S. Treasury bills!<\/p>\n

This normalisation process will take time<\/strong> and
\nin all likelihood, the target level for key rates
\nwill be much lower than it was in the past. It
\nwill also be very gradual: central bankers are
\nperfectly aware of their important role in
\ndriving capital markets and now pay great
\nattention to \u201cpreparation\u201d – as they do when
\nmanaging the probability of a Fed fund hike
\nahead of each meeting. Currency market
\nvolatility has created an additional challenge
\nfor central bankers. Officially, they do not
\nhave forex objectives; however markets
\nsometimes react violently depending on the
\ndecisions they make. The interaction between
\n\u201cdriving markets\u201d\/ \u201cmarket over-reactions\u201d to
\nthe statements made\/measures taken by
\ncentral bankers is particularly challenging.<\/p>\n

The structure of the market has also
\nundergone durable change, driven by the
\nnumerous and diversified regulatory measures
\nimpacting banks, insurance companies and asset managers. As a result, deals between
\nfinal investors have grown significantly
\n(intermediation). Questions remain over the
\nreal and effective liquidity<\/strong> that will be
\navailable in crises to come. Some market
\nobservers have rightly pointed out that
\nliquidity is available when investors have little
\nneed for it, and then disappears when they
\nrequire it. Measuring liquidity objectively is an
\nextremely difficult task in markets operated by
\nmarket makers, who have no interest at all in
\nbeing transparent over their capacity for
\nposition-taking. <\/p>\n

\u2018\u2018Regulation impacts liquidity
\nas a whole and this will be a
\nmajor challenge when
\ncentral banks leave the scene\u2019\u2019<\/quote><\/p>\n

Events of recent weeks have shown how
\npolitical developments can cause disruption to
\nfinancial markets. First in line is U.S. domestic
\npolicy, with President Trump\u2019s unpredictable
\nbehaviour and the procrastination over the
\nproject for fiscal reform. In Europe, the impact
\nof Brexit \u2013 both on the British economy and
\ncapital markets, including international \u2013 has
\nnot been truly factored in. Furthermore,
\ndevelopments in the emerging world often
\ntend to be overlooked when analysing market
\nchanges. Yet China is undergoing considerable transformation; the government is
\ndetermined to bring about change and to
\ncreate a service-driven country based on a
\nsustainable economic model. This
\ntransformation implies major investment in
\nrenewable and all-electric energy, but also
\nabroad, via the \u201cOne Belt, One Road\u201d
\nprogramme designed to bring China closer to
\nEurope via the Middle East. <\/p>\n

\"one_belt_one_road-3.jpg\"<\/a><\/p>\n

Clearly, this major crisis has caused deep
\nchanges to the global economic environment
\nand to the way capital markets operate. These
\nupheavals that are currently at play are still
\ndifficult to grasp; and in any event, they
\ncannot be measured effectively using available
\nstatistical tools. However, in the short-term,
\nsome areas of certainty remain, such as the
\ncontrols exerted by central banks on fixed
\nincome markets.<\/p>\n

As no one expects inflation to accelerate
\nsharply, the control from central banks does help to limit the risk of a crash on bond
\nmarkets.<\/p>\n

Nonetheless, it is true that a badlyorchestrated
\nrise in interest rates can trigger a
\nsevere correction in equity markets. We are
\nalso convinced that the credit market will be
\nsubject to the ECB\u2019s tapering policy sooner or
\nlater. <\/p>\n

In this environment, we shall clearly favour
\nequities over credit investments in developed
\nmarkets, while leveraging on current
\nopportunities in emerging markets<\/strong> (both
\nbonds and equities). This new market
\nenvironment is not as favourable as it once
\nwas to contrarian position-taking; markets are
\nmomentum-driven at the moment and due to
\nregulatory changes, banks have invested less
\nof their own equity in the market. <\/p>\n

Nevertheless, according to financial theory,
\nthe \u201cmomentum approach\u201d has not shown a
\nclear ability to outperform a \u201ccontrarian
\napproach\u201d in the context of asset allocation.<\/p>\n

It will therefore be important to use
\ndiversification<\/strong> as a performance driver
\n(always useful as long as the \u201ctrue\u201d
\ncorrelations between assets are estimated \u2013
\nhence the importance of a multi-scenario
\napproach); fund managers will also have to
\ndemonstrate a high degree of flexibility<\/strong> in
\norder to adapt to the various shifts in market
\nregime that are bound to occur.