By Cees Bruggemans
We have had our fair share of market tantrums by now, originating in the US financial system, and focused on the anticipation of the Fed normalisation strategy following years of highly unconventional, indeed extreme monetary policy positioning.
Thus we find from time to time markets becoming upset with events, reading into it what they will, greatly increasing the volatility of price movements, in the process feeding a sense of risk, and this having serious fallout consequences for the fragile likes such as ourselves and many other Emerging Markets (EMs).
What can in this regard still be expected to lie ahead?
Firstly, the Fed is possibly less than half way through its policy normalisation. It started in earnest in May 2013 with open-mouth expressions by Fed chairman Bernanke, looking ahead to the start and completion of QE bond buying tapering (in the end begun & completed in 2014).
It has since, during the first full year in office of Fed chairman YelÅen, shifted to betting on the start & completion of interest rate normalisation from a position of rest (0%), generally expected to run through 2015-2017.
And we still need to consider deleveraging of the Fed balance sheet, if that were to be a policy issue post-2018.
So it is a very long process, during which market turbulence can occur.
Secondly, then, the incidence & nature of such tantrum disturbances causing so much potentially costly collateral damage. What in heavenās name moves people to act like that?
Surveys overseas have shown, surprisingly, considering just how uncertain the future is, that there are many participants peopling markets who hold deep convictions about likely Fed moves. This was true for the onset & completion of bond buying tapering. And it is more than ever true of expected Fed interest rate moves, yet in an environment that is hardly āslam dunkā if truth serum prevailed.
The problem with having so many, richly divergent market opinions at any one moment in time is that many are going to be disappointed when their number isn’t called.
And it is in the nature of markets that if your number isn’t called, you bail out at a loss. With many bailing at every critical juncture of this betting process, the world is set up for serial upsets (volatile market tantrums ā price movements) if and when yet another critical benchmark along the Fed normalisation trail heaves into view.
Thus such asset price discovery is costly, which is its nature, especially when the leading central bank is so far off the conventional reservation, and has to grope its way back through many hurdles, hiccups & upsets.
The tantrums are not all one-way, however, as we saw again last week and into this week, where the Fedās dropping of the term āpatientā was accompanied by moderating forecast views about growth & inflation, hauling many in various markets back from extreme positions (not least a rising Dollar that had got ahead of itself).
So yes, there is more pummelling ahead for fragile risky EMs, but it mostly originates with faulty calls in the larger global system inviting corrections whenever another small piece of the bigger normalisation puzzle comes into view.
It doesnāt mean we will get sunk serially way beyond fair value. Tantrum can go either way, as again shown over recent weeks. The discovery process is lively, and yes, underlying it all is a rise in US interest rates and a rising Dollar, accompanied by much greater risk discernment about EM Fragiles, which imposes its own penalties over time.
Many of the free-and-easy freebies are gone. But a complete rout & sinking of Fragiles it isn’t either. Instead, think of shifting furniture within established structures, rather than seeing the house demolished in the process.
So tantrums aren’t necessarily demolition derbies, even if they sometimes feel like it. But that cannot be helped as the world transforms back to conventionality after eons of being thoroughly unconventional.
The only real saving grace? It will probably proceed only very, very gradually, given the state of global recuperation in post-crisis mode. That is a priceless benefit to true Fragiles. For without it we would have been genuinely trashed, quartered & sunk.
But then this is a Walt Disney production, not a Jerry Bruckheimer, Sam Peckinpah, Quentin Tarantino or Paul Verhoeven in full cry. A gentler, kindlier world, remember Bush Senior?
