The Battle at the Heart of Global Markets
Global markets tug of war means more volatility for investors
By Richard Barley
Global markets are undergoing a titanic tug of war.
On the one side is the decent, if not spectacular, growth in developed economies like the U.S. and U.K. that is prompting the Federal Reserve and the Bank of England to lean toward increasing rates for the first time since the global financial crisis hit. Even the eurozone has shaken off recession and is growing again.
On the other side, however, is the fear of a new deflationary tide from slowing emerging-market economies, accompanied by a collapse in their currencies, and swiftly dropping commodity prices. Risk premiums are rising in credit markets, causing further nerves.
The result is volatile and confusing markets for investors to navigate.
Government bond markets are caught at the heart of it. In August, U.S. Treasurys have swung between an intraday low yield of 2.05% and a high of 2.29%, according to FactSet. Mostly decent U.S. domestic data haven’t been enough to offset the downward pressure on yields spilling over from oil and commodity prices, pushing yields down to 2.10% now. U.K. gilt yields spiked higher this week on a stronger-than-expected “core” inflation reading—excluding energy, food, alcohol and tobacco—before wilting in the face of global pressures. Ten-year German yields are in the middle of the year’s range around 0.59%, torn between a eurozone recovery and a renewed challenge to the European Central Bank’s inflation target.
Worrying, but mixed signals are being sent by riskier bonds. U.S. high-yield bonds have fallen sharply since early June, which might indicate fears of a renewed economic downturn. But much of this is down to the energy and metals and mining sectors. Other growth-sensitive sectors have held up better: the gap between yields on energy and consumer cyclical high-yield bonds has risen to 4.3 percentage points from two points, with the latter proving relatively resilient, data from Barclays indexes show.
Investment-grade corporate bonds are suffering, another potential warning sign. But here too there are alternative explanations: a rush of supply and a trend toward corporate releveraging.
Meanwhile, developed-market stocks are feeling the chill: even European equities, a much-favored trade for 2015, are a long way from their highs for the year.
The renewed decline in oil prices and events in emerging markets such as China’s devaluation of the yuan mean the deflationary and slower-growth camp appears to have the upper hand in the tug of war. Yet while lower oil prices clearly are a drag on headline inflation near-term, they are also good news for large numbers of consumers and businesses; low inflation is also leading to real wage gains. Emerging markets are showing greater flexibility than in the past thanks to floating-rate exchange regimes and relatively strong sovereign balance sheets.
The other way to read the turmoil in markets is that investors are demanding a higher premium for uncertainty. With the Fed seemingly heading toward its first rate increase, after a period in which monetary policy has bent over backward to support markets, perhaps that shouldn’t be surprising. But it suggests markets won’t catch a break from volatility any time soon.
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