By Mike Dolan
LONDON (Reuters) – Hold on to your hats.
Central banks appear in no mind to rehabilitate the forward policy guidance prevalent before the pandemic and that’s forcing investors to wing it alone, injecting greater market dispersion into next year and a possible boom in more active portfolio trading.
When Federal Reserve boss Jerome Powell effectively stopped formal signalling on the long-term path of interest rates last year, there was an assumption it merely reflected the thick fog central banks faced in reading COVID-related supply disruptions and Ukraine-related energy spikes.
But it may not be coming back, if the latest central bank pronouncements around the world are anything to go by.
The quiet shelving of the tactic – frequently used over the past 20 years to keep markets in check and suppress excess volatility – is not solely down to lack of visibility. Rather, it looks like a deliberate attempt to keep markets guessing, in part to prevent excessive one-way risk taking.
On one level it merely acknowledges a less predictable global economic regime. On another it’s a return to an old familiar ‘normal’.
This feels much more like the 1990s, when central banks reserved the right to surprise, switch direction, lean back and forth against the economy and markets and take incoming high frequency data at face value.
And if you think rates are on a glide path in any one direction, or even stuck where they are, you may have to think again.
Rates may stay technically ‘restrictive’ as befits the ‘higher for longer’ mantra while still being cut nominally by a percentage point or more – depending on which of the blizzard of differing forecasts you sympathise with. And the possibility of another round of hikes after a cut or two may not yet be off the table either.
This week was a classic case in point when long-standing European Central Bank hawk Isabel Schnabel told Reuters she’d changed her mind about the likely persistence of inflation on the back of the latest impressive monthly price updates.
But, just as importantly, she doubted she could give any confident steer on the state of play into next year.
“We have been surprised many times in both directions,” Schnabel said. “So we should be careful in making statements about something that is going to happen in six months’ time.”
That’s less of an ECB quirk than a mirror of central bank thinking at large.
It’s already evident in Treasury bond volatility gauges some 50% above historic averages – with the mean over the past four years some 30% above that of the prior 10 years.
The swings are everywhere, not least in UK money markets that were pricing in 6% peak Bank of England rates just three months ago but are now pencilling in cuts of up to 100 basis points to 4.25% in 2024.
‘DISPERSION IS BACK’
This packs a very big punch for many investors trying to parse portfolio management over the coming years.
In their annual outlook for 2024 this week, strategists at the world’s biggest asset manager BlackRock stressed that they saw this topsy turvy world as a macro environment that’s here to stay for the foreseeable.
“Dispersion is back,” said Wei Li, chief investment strategist at the BlackRock Investment Institute.
“After the GFC (Global Financial Crisis of 2008) central banks took out a lot of macro uncertainty with their forward guidance,” she said. “But now as they themselves are uncertain what they will do in six months time, the room for having more differentiated views is greater.”
The BlackRock team pointed to the rising dispersion of U.S. equity analysts’ corporate earnings estimates, the median of which was almost 50% higher in the three years since the pandemic than over the previous 25 years.
And it also showed how hypothetical ‘buy-and-hold’ strategies on U.S. equities over the past four years would have more deeply underperformed those with annual or semi-annual portfolio rebalancing than in the four years prior to 2020.
Underlining that, BlackRock said it was unwise to take simple blanket positions globally or even by asset class or sectors, with geographical variations and even subsectors possibly at odds and moving in different directions.
For example, they said they are underweight fixed income but like investment grade credit in Europe and not in the United States. They like bank stocks in Europe, but in ‘less competitive’ markets like Italy, Spain and Ireland rather than the UK or Nordics.
And an underweight position on U.S. stock benchmarks overall masked their overweighting of technology and those stocks within the artificial intelligence theme.
It may beg the question why equity market volatility measures are still so low. But these are hinged on indexes rather than the churn under the bonnet, and the alternative ‘hedge’ is average 8% cash levels in wealth management portfolios, twice levels seen in 2020-21.
Of course, predictions of such ebb and flow and switching may partly be wishful thinking among active fund managers, long in the shadow of cheaper and sweeping passive index plays that rode the indiscriminate liquidity waves of the past 15 years.
It certainly nods to banks and brokers who will no doubt benefit from the extra investor churn and trading income.
But there’s little doubt that markets are prone to turning on a dime right now. Today’s credit easing euphoria could shift quickly again.
“Markets can be very short term in nature and they will just focus on what’s coming around the corner,” said Ed Hutchings at Aviva Investors. “But it can take a long time to tame the levels of inflation we’ve seen.”
How long that battle will take has become anyone’s guess and policymakers are no longer willing to commit.
The message from central banks is loud and clear, according to BlackRock’s fundamental fixed income head in EMEA Michael Krautzberger.
“You’re on your own now.”
The opinions expressed here are those of the author, a columnist for Reuters
(Editing by Kirsten Donovan)
