Monday 20 November 2017

Jitters in the market as old reliables Bernanke and Beijing look unsteady

Fed chairman sparks fear with bond-buying comments while China engineers cash crunch

US Federal Reserve chairman Ben Bernanke has signalled an end to easy-money policies
US Federal Reserve chairman Ben Bernanke has signalled an end to easy-money policies

Jonathan Spicer

Through the dark days of the financial crisis, and the grey days of the halting recovery that have followed, investors have always been able to count on backing from two sources – Ben Bernanke and Beijing.

They have provided stimulus, mainly by pumping funds into the US and Chinese economies in various ways, when other pillars of support had become unreliable.

That helps to explain why global financial markets took such a beating last month, when both signalled they were getting tired of being leant on so heavily.

Mr Bernanke, the chairman of the US Federal Reserve, set a timetable at last week's Fed meeting for the central bank to reduce the size of its bond-buying programme with a view to ending it by the middle of next year.

Meanwhile, his counterparts at the People's Bank of China (PBOC) engineered a cash crunch as a warning to overextended banks – and this from a central bank that has previously always provided liquidity when cash conditions tightened.

A lot will now depend on whether this kind of behaviour from either hurts the global economy enough to seriously damage the confidence of businesses and consumers, with the resulting fallout for spending, corporate profits, and hiring.

"A trading environment once predicated on free money forever is now being reassessed," said Eric Green, TD Securities' global head of rates research, in a note to clients.

The prospects of the Fed stopping its easy-money policies "leaves few willing buyers to step in" as prices drop, he said.

In China, a sudden leap in rates for short-term borrowing to record highs should help rein in so-called shadow banking, the lending being done by non-bank institutions, but there is the risk of a miscalculation that could set off a full-blown banking crisis even as the economy is showing fresh signs of slowing.

"It does create a lot of repayment risk within the system between financial institutions and there is potential for unintended consequences," said Charlene Chu, senior director at Fitch Ratings.

A possible miscalculation is also the concern of St Louis Federal Reserve president James Bullard, who complained that Mr Bernanke spoke too soon about reducing stimulus.

Neither the central bank's own economic growth forecasts nor its expectations for continued weak inflation supported a decision just yet to dial back on the $85bn (€65bn) a month it has been pumping into the financial system, the St Louis Fed said in explaining Mr Bullard's thinking.

Mr Bullard, who dissented against the decision, wanted "a more prudent approach", that would have meant waiting for clearer signs that weak inflation would rebound.

While Mr Bernanke made it clear that the Fed's actions would depend on whether the economy continued to improve, he based his forecast on expectations that growth would be buoyant enough to bring the US jobless rate down to near 7pc in a year's time from 7.6pc.

Investors had known the central bank was starting to consider less accommodation, but the level of detail surprised them.

So did the return of the Fed to calendar-based guidance on what it intended to do, after months of attempts by Mr Bernanke and other top officials to tie the bond buying, known as quantitative easing, to the economy's performance.

"The average investor is just so dependent on quantitative easing to act as that safety net that, even though it was forewarned, it still came as a shock," said Bruce Bittles, chief investment strategist for brokerage Robert W Baird & Co.

The risk is that there are more major disruptions in financial markets in the next few months as investors pull back for fear of the unknown – and that rising interest rates and a decline in the value of stocks and bonds start to feed into the real economy as consumers and companies cut back spending.

That could stall the housing market recovery and reduce expectations for retail sales and capital investment, which would quickly feed into lower corporate earnings growth and weaker job creation.

To be sure, on housing and the economy, Mr Bernanke was hopeful last week – saying that people "expect house prices to continue to rise" – and stressing that when interest rates rise for the right reasons it is "a good thing".

JPMorgan chief US economist Michael Feroli said he mostly expected economic data to play out as the Fed predicted.

"Were the economy to stumble, however, history may look back on this meeting as one where the Fed once again jumped the gun," he said.

Given such uncertainty for global markets, the last thing that was needed last week was concern about stability in the Chinese banking system.

The PBOC let short-term interest rates spike to extraordinary levels – the cost of borrowing overnight funds surged to 25pc for some institutions – as it refused to inject funds into money markets.

The jitters spread more broadly late last week, amid rumours – passed on by Chinese media outlets – that two major banks had received emergency funds from the PBOC circulated in financial markets in London and New York.

The lenders denied the rumours, after which money markets calmed.

But the episode has added to some wider concerns among investors that the Chinese economy is over-extended, with overall financing rising 52pc in the first five months of this year compared with the same period in 2012. Of particular concern are big sales of wealth-management products that promise investors high returns.

Given the growing importance in recent years of an earnings stream from China for many large American and European companies, any stumble by China could have wider ramifications.

Many companies are finding it difficult to raise prices in the current environment, which can hurt their margins. And even those who are relatively bullish in one market or another are keeping their expectations very much in check.

"'Down a little' is the new 'up' – for now," said Doubleline Capital's CEO Jeffrey Gundlach, who is bullish on Treasuries despite last week's worst sell-off in the benchmark 10-year market in more than a decade.

Jonathan Spicer is a Reuters correspondent

Irish Independent

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