When the global economy is slowly recovering and the world’s big central banks remain fundamentally dovish (even as they gradually ease off on the stimulus), it is very hard to deter asset markets. Stocks, in particular, have marched stoutly upwards for years.
Moments of equivocation have been brief. The most recent one came last month, with a sudden spike in volatility, the apparent result of a crowded trade in stock derivatives being rapidly unwound. Once again, though, the market bounced back merrily.
That is, until now. The ascent back to January’s highs has been interrupted by what Americans might call a doozy of a week. Jay Powell, chair of the Federal Reserve, tried to keep the markets calm, stating his commitment to a slow and steady pace of increases. The Open Market Committee is now evenly split on whether to raise interest rates three or four times this year. The Fed received a somewhat unsettling reply from the markets: sorry, but we do not much believe you.
The Fed’s “dot plot” that tracks committee members’ expectations suggests the Fed funds rate will hit 3.4 per cent by 2020, twice its current level. Despite this and Mr Powell’s resolute commentary, the 10-year bond yield has flatlined at around 2.8 per cent. More striking, the three-year yield is at 2.4 per cent. Investors think the Fed will have to relent in the face of a weaker economy, choppy markets, or both. If they believed anything else, yields would be higher.
President Donald Trump did not spend his week reassuring markets. First, he announced tariffs and other measures designed to punish China for its unfair industrial policies and theft of intellectual property. The Chinese promised to retaliate, and the stock market saw the opening salvo of the trade war — a possibility that has been discussed, and dismissed, since Mr Trump was elected. Trade-sensitive industrial groups such as Boeing, 3M and Caterpillar fell by as much as 5 per cent Thursday.
American banks got hit hard, too — hardly an expression of confidence in the economy, or in Mr Powell’s expectation of steadily raising rates. Markets in Japan and Germany, the large nations most dependent on global trade, fell too, continuing a recent trend. Those markets are already lower than their lows during the volatility spike. This was bad timing, as the sector that had led US stock markets upwards, technology, was being hit by Facebook’s meltdown over privacy.
Nor was the week over. Mr Trump’s next move, on Thursday evening, was to sack one of the White House’s so-called “grown ups” and replace him with the unrelenting John Bolton, who has argued for pre-emptive military action against Iran and North Korea. Oil prices jumped.
It is just one week. The current anxiety may dissipate and markets may regain their zest. But something does appear to be changing: moments when the stock and bond markets signal caution simultaneously have not been common in recent years. That is most certainly happening now.
When markets were roaring, Mr Trump took too much credit for it, and he cannot take all the blame for the recent wobble. But the market is sending him a message, and part of that message is about his trade and foreign policies. This bull market is old, assets are still expensive, and investors are palpably cautious.
Undermining global trade and striking a belligerent posture towards Iran or North Korea could turn this caution into fear. Mr Trump is known for ignoring his advisers. We should hope he is more attentive to markets.
