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Time to relax?

Markets appear on a surer footing following the volatility at the start of the year, but can it last?

  • The much-heralded return to volatility hasn’t happened, with the Vix index back to low levels
  • Many central banks remain in easing mode, but it would only take one to flip for the balance lie with tighter monetary policy
  • Markets haven’t panicked in response to President Trump’s trade tariffs, but it presents a real risk for companies.

Markets appears to have regained some poise after their little wobble at the start of the year. Admittedly, they’re not exactly charging forth, but neither have they looked in danger of a further rout. The much-heralded return to volatility hasn’t really happened, with the Vix back to levels seen in late 2017. Can we afford to relax a little? Or is the market complacent?

It remains difficult to see how the great monetary easing experiment could draw to a close without creating some kind of volatility. The trouble is, it hasn’t drawn to a close yet. Yes, the US is raising rates and yes, the ECB has dropped its explicit commitment to buying bonds should the economy weaken. However, for the time being, the ECB and Bank of Japan are still in easing mode.

Scott Thiel, deputy chief investment officer of Global Fundamental Fixed Income at BlackRock, points out that the US is around 40% of the world’s government bond market, so while other countries remain in easing mode, they hold the balance. However, were one of those other countries – and it could be the ECB, Bank of Japan or the Bank of England – were to tip into tightening mode, the balance would lie the other way. This may be the tricky point.

The problem is that markets may start to anticipate this ahead of time. This was the problem at the start of the year. Markets had not yet fully adjusted to the environment. They have moved closer, but aren’t all the way there yet.

As ever, the big unknown remains inflation. It seems clear that inflationary pressures are starting to emerge, particularly in the US. This is before any real impact from President Trump’s tax cuts. Most believe that these tax cuts will hasten the end of the cycle, forcing higher rates earlier than might otherwise have been expected. At the same time, China, long a deflationary force in the global economy, is now likely to be more inflationary as it backs away from cheap manufacturing.

Then there is the trade tariff problem. Markets haven’t panicked in response to President Trump’s trade tariffs, but if it prompts tit-for-tat tariffs on goods and services across the globe, it creates hurdles for companies to grow their earnings. North Korean relations may have turned a corner, but – as the UK’s problems with Russia show - there is still plenty of geopolitical risk out there.

In short, it may all be fine, but it’s not a time for investors to take their eye off the ball. Markets may have recovered some balance, but there is much that may disrupt them from here.

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