Asset Management

Diverging Central Banks Policy Could Cause Financial Market Volatility in Q4, Warns JP Morgan

Mark Shapland Reporter London 8 October 2014


Investors can expect market volatility in the final few months of this year as better performing economies start to break away from their weaker rivals, JP Morgan Asset Management has warned.

Investors can expect market volatility in the final few months of this year as better performing economies start to break away from their weaker rivals, JP Morgan Asset Management has warned in its final quarter Market Insights report.

The gulf in performance – in particular the US and UK economies compared to the Eurozone - is likely to be reflected in diverging central bank policies which in turn will cause uncertainty in financial markets.

“The world's economies are recovering at very different rates and this divergence is about to show up in the policies of the major central banks,” said Stephanie Flanders, chief market strategist, UK and Europe, JP Morgan Asset Management. “This is going to have complicated implications.”

The former BBC economics correspondent added that historically, when monetary policy has been going in different directions on both sides of the Atlantic, upsets and volatility have been the result.

Perhaps the most famous example came in 1987 when Treasury Secretary James Baker blamed the US stock market crash of that year on a slight upward shift in the Bundesbank's interest rate governing money market funds – otherwise known as the repo rate. Throughout 1987 the US had made clear its desire for lower German interest rates but a key group in the Bundesbank led by then President Helmut Schlesinger argued that the growth in money supply would eventually come out in the form of inflation.

“You only have to go back to past periods to when monetary policy had been going in different directions on different sides of the Atlantic to see scope for upsets and volatility,” said Flanders. “In the past it has tended to be the Bundesbank tightening and being concerned that the US was not worried enough about inflation and was allowing the dollar to collapse.”

Flanders also made clear that Eurozone performance is now at a “crunch point” and another recession looms for the bloc if it cannot turn itself around. According to the IMF, the region is expected to grow by just 0.8 per cent this year, with little hope of a interest rate rise in 2015.

“The problem of low growth and low inflation if you're a highly indebted country that it is a highly difficult position to sustain and I think that is what has brought some of these concerns back to the fore in the Eurozone,” Flanders said.

“There's something of a crunch point coming in the Eurozone in the next few months. Things could turn around or start going in a different direction - it is the economic and the political that need to come together. At these current growth rates the Eurozone is vulnerable to any shock that comes along. There was a worry over the summer that the Ukraine/Russia situation might tip the Eurozone back into recession and that is still possible,” she added.

In contrast, the UK and the US has started to pull away from its Western economic rivals. The US economy grew 4.6 per cent year on year in the second quarter this year – the fastest growth rate in three years – and leading to speculation that Janet Yellen at the Federal Reserve might raise interest rates before the middle of 2015. Meanwhile figures from the Office of National Statistics anticipate a growth rate of 3.2 per cent in the UK – up from 1.7 per cent in 2013.

Yet Flanders cautioned investors about strong growth rates leading to near term interest rate rises and expects both the Fed and the Bank of England to keep them unchanged from current levels.

As a result, investors should stay “overweight” in risk assets and equities despite the asset class being expensive and some analysts suggesting that the markets are in a bubble. 

“We are still in a world where central banks want more inflation and more growth than they are currently getting and that's including the US. It is still biased towards reflation in a way that we haven't seen for a long time,” said Flanders. “Liquidity conditions will be looser for longer and in that environment it rewards risk takers. But you shouldn't expect the kind of rewards from equities that we've seen in the last few years and you should expect more volatility.”

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