Will Central Banks’ Retreat Help?
08/11/2011 10:59 am EST
The combination of slower economic growth and a global stock market rout are enough to change the strategies of central banks around the world.
The almost uniform global response from central banks has been to drag out or cancel interest-rate increases that were in the works. In general that will help stock markets—but how much they help an individual market depends on how convinced investors were that the central bank was serious about hiking rates in the first place.
For example, in the United States, the Federal Reserve has already told the market not to expect higher benchmark interest rates until 2013. Investors who have watched the gradual slowdown of the US economy had already decided that the Fed wouldn’t move in 2011, as had seemed likely earlier in the year.
With investors already pushing their expectations of any rate increase from late 2011 to early 2012, the Fed had to move the goal posts dramatically—into 2013—to have any effect.
Good news for all those procrastinators who now have more time to lock up a low mortgage rate. Bad news for savers who are facing another year of living with sometimes-negative short-term yields and savings accounts paying as close to nothing as matters.
Some good news for stocks in that—although it’s not clear that lower interest rates make stocks that much more desirable when growth is slowing.
In the Eurozone, the European Central Bank is sticking—verbally—to its policy of raising interest rates once or twice more this year. But with Spain and Italy wobbling, the market is starting to assume that any actual interest rate increases are on hold.
What European bank president Jean-Claude Trichet has done most effectively in his last year in office is impress the financial markets that the bank sets policy at the whim of politicians and markets. That will put big pressure on Trichet’s successor to rebuild the market’s belief in the credibility of the bank.
I think you can count on the bank to adopt a more Fed-like communications policy to explain why it is doing what it is doing—and to raise interest rates in a big surprise move as soon as the European Financial Stability Facility is in place to do the stuff that the bank doesn’t want to be seen as doing. (Like buying sovereign debt in the markets.)
Look for that surprise in as little as a few weeks, or as long as a month or two. A resumption of the European Central Bank’s interest-rate increases will strengthen the euro against the US dollar and send commodity prices higher. (Commodities tend to be priced in dollars, so they rise in price as the dollar falls.)
As the case of Australia indicates, when a central bank has a credible record of raising interest rates to fight inflation, the prospect that global turmoil will put the bank on pause can really boost stocks.
It’s been hard to tell in the midst of the global stock-market rout recently, but the Australian stock market has been moving up strongly on announcements from the Australian central bank that rate increases are likely to be postponed while the global economy is so uncertain.
The two most interesting cases now, however, are the People’s Bank of China and the Banco Central do Brasil.
The People’s Bank may have been nearing an end to its interest-rate cycle anyway, with inflation—perhaps—at a peak of 6.5% in July. But a global economic slowdown that will hurt China’s exports is enough to put China’s interest-rate hikes on hold several months early.
Given how fearful Chinese investors have been of central-bank policy—and given how popular trying to game central-bank policy is with Chinese traders—I’d expect the global economic slowdown to be a big plus for shares of China’s domestically oriented companies.
The Banco Central do Brasil has been less successful than the People’s Bank in bringing Brazil’s official rate of inflation under control, largely because Brazil’s currency (the real) has appreciated against the dollar, resulting in a huge flood of hot money into the country. (China’s yuan is, in contrast, tied in price to the US dollar, with a floating peg.)
Brazil’s high interest rates—the benchmark Selic rate is over 12%—aren’t likely to result in much relief for Brazil, even if the global economy slows. Money will continue to flow into the country, driving up prices.
At the same time, Brazil seems to be suffering an actual bout of wage inflation as a result of a labor shortage in some sectors of the economy and a bloated state sector. Nonetheless, a pause by the Banco Central, which I expect, would bring needed relief to the banking sector, where higher interest rates have pushed an increasing number of consumers toward delinquency on their loans or credit cards.
As with China, in Brazil I’d look at domestically oriented companies, rather than the shares of exporters.
All these thoughts are early-stage speculation. The global crisis of confidence and the economic slowdown still have a ways to run before we know their full scope.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio here.
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