The world's most powerful central bank and others have cut rates or are expected to keep monetary policy loose. A decade on from the 2008 crash, it appears that it will be some time before rates return to a "normal" state.

The US Federal Reserve recently trimmed official interest rates by 0.25 per cent, or 25 basis points to a target range of 2 per cent from 2.25 per cent. The move matched expectations. It’s perhaps a sign of how uneasy policymakers are about economic prospects that rates are as low as they are (when inflation is factored in, they are close to negative), and yet the Fed still pulled the trigger. The era of double-digit interest rates belongs to another universe. To consider recent events and what the financial markets hold is Adrien Pichoud, chief economist at Switzerland’s SYZ Asset Management. The editors of this news service are pleased to share these views and invite readers to respond. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

Central bankers have finally given in to the accumulation of adverse developments and mounting downside risks. The combination of slowing global growth, weak inflation, falling expectations, rising geopolitical tensions and the extended impact of trade tensions led to the same conclusion in Washington DC, Frankfurt and Tokyo – it is time for monetary policy to be eased, concretely.

This simultaneous pivot is obviously linked to broad-based slowing activity across developed and emerging economies. Defying expectations of a pickup in activity, especially in Europe and China, global growth has remained on the soft side and keeps losing steam. 

For the moment, resilient domestic demand across most developed economies stops them falling into recession. This has prevented central banks from embracing effective monetary policy easing. However, manufacturing indicators remain quite depressed, reviving the risk that cyclical sluggishness might finally spread to the resilient consumption-driven side of the economy. In fact, global sentiment keeps weakening and employment dynamics are faltering.

The straw that broke the camel’s back was probably the drop in inflation, further threatening central bank targets, and proof that the developed world is “Japanising”. Whether monetary policy easing will have an impact on inflation remains to be seen, but as long as growth and inflation dynamics stay subdued, central bankers will have reason to maintain a very accommodative stance – if anything, to try to preserve credibility.

As a result, the European Central Bank president and the Federal Reserve board both warned that they expect short-term rates to be cut in the coming months, while the Band of Japan governor signalled some flexibility to the downside on the long-term yield range. The trend towards monetary policy easing is also gradually encompassing emerging market central banks, against a backdrop of soft growth and inflation, combined with a US dollar that is no longer appreciating.

The dovish pivot from the Fed and the ECB will influence the future path of policies and have a significant impact on financial markets. By forcing market participants to keep or add risky assets to avoid the monetary forces of financial repression, this will far outweigh the impact of growth or inflation dynamics.

Hunting for yield
Given these developments, we have upgraded the portfolio risk stance to a ‘mild disinclination’. We are implementing this through some ‘carry’ assets in fixed income markets, via credit and emerging market debt in foreign currency.

As we did not fully participate in the core government bonds interest rates rally, we are not comfortable with adding pure duration at this point - we expect a temporary pullback after the steep rise in valuations. However, we are taking some indirect duration risk through additional credit and emerging market hard currency debt.

We brought investment grade credit up by two notches to a "mild preference" and high yield up by one notch to a "mild disinclination", preferring European over US credit on valuation grounds, as well as due to the steepness of the euro yield curve and ECB dovishness. Italian linkers and nominal bonds are becoming one of our top picks - along with the US - and were both upgraded to a “mild disinclination” and a “mild preference”.

The backdrop for emerging market debt remains favourable, especially if the Fed eases monetary policy and the US economy does not fall into recession. Moreover, valuations are attractive compared with credit or European peripherals. In the hard currency bucket, Brazil was upgraded to a "mild preference" benefitting from the support and confidence of foreign investors. Indonesia local currency debt was also upgraded to a "mild disinclination" as the economic environment remains favourable, with inflation under control and a central bank that could soften its restrictive stance.

On the other hand, as long as there are no tangible signs of economic growth re-acceleration, equity markets should remain volatile, with limited upside. With rates at artificially depressed levels, equity allocation needs to be tactical and investors should look to growth trends, as valuations are becoming less important.

Europe, China and Japan will potentially be the first direct or collateral victims of growth disappointment and an intensifying trade war over the next few months. Therefore, European, Chinese and Japanese equity markets are scored at a "mild disinclination", while the US and emerging markets are one notch higher at a "mild preference". High dividend stocks should be less at risk of a temporary interest rate repricing and offer a real alternative in the low-rate environment.