Graphic content; What’s driving the risk rally? Central Banks
28th February 2019
Financial markets in December shocked many investors; the S&P 500, a bellwether for global stock markets, fell around 9%, its worst month since October 2008, the peak of the Global Financial Crisis. This capped off a terrible year for most asset classes, especially risky assets such as stocks and corporate bonds.
Fast-forward a couple of months, and things have changed – the risk party is back – goldilocks has returned. In a remarkable reversal of fortunes, in January the S&P returned around 8%, one of its best months since the financial crisis, and the index has been positive again in February, returning around 3.5%. The dip has been bought.
What explains this sharp reversal? One could argue that it’s positive political developments: the US shutdown has ended, while a China-US trade deal seems ever closer. However, we believe that the real driver is a more familiar friend: central banks. The Federal Reserve made an almost 180-degree turn on its policy, while over in Europe the European Central Bank has also become more dovish, lowering their outlook while also discussing potential further easing via longer-term refinancing operations (LTRO). Markets repriced monetary policy going forward, and this was most acute in the US, where implied rates for 2020, for example, have moved a staggering 90bp lower; that is almost four hikes being taken out. Investors in risky assets have said ‘thank you very much’.
The chart below nicely highlights how violently markets have repriced rate expectations since November 2018. While in the short term the rate market may have overreacted, there is little doubt in our minds that we are at the end of the rate-hiking cycle. We have gone from a series of hikes to the current pause. We believe the next big theme will be rate cuts.