Felix Stephen said he suspects that the market hasn’t yet shown a blowout. It’s just about possible that we might see that happen because now we are right deep into the period when he thought we would see maximum turmoil in terms of political developments, especially in Europe.
He said sometime between now and mid-October is a period that’s going to be extremely volatile, and if we do make a low it’s going to be right now. Or on the reverse, if we start cracking through the topside, then most of the negative news is already priced in and the market is vulnerable to that.
Possible risks remain in Europe. While the Greek default is now increasing, or the possibility of a Greek default increases, the vulnerability for the market to fall also increases. But that doesn’t mean to say that Greece will exit the European Union, because it doesn’t serve them and it doesn’t serve the European Union. The costs of getting out are extremely high.
We are going through a highly critical period so at this point in time the risks have risen quite sharply. But once that’s out of the way, the fact remains that we are going to see a lot of tailwind support coming from various authorities, in particular from the Central Bank. The outlook that is being painted by most of the authorities think of 2012 being a better year in terms of growth will in fact help us a lot because, somewhere in here, the market will find itself in a position where all the bad news is priced in and it will start moving higher.
So the outlook, again, is that you will never pick the top or the bottom of a market perfectly, but when you do get opportunities to pick assets that are relatively cheap and have upside potential, that’s exactly how you should position yourself. So the risks are high but then you’ve got to take those opportunities to accumulate risky assets when the time is right.
US Operation Twist
Earlier this week, the US announced Operation Twist. The market did not react favourably. Here is the Advance take on the announcement.
“Operation Twist” is the US government’s latest attempt to both drive down long-term interest rates while simultaneously reinvigorating the stalling US economy. It takes its name from a similar program launched by the Kennedy administration in the early 1960s which attempted to twist or flatten the shape of the treasury yield curve to promote capital inflows into the US, which it was hoped would strengthen the US dollar.
Currently there’s much debate within the economics profession about the efficacy of such policy action – will Operation Twist indeed boost real economic activity and thus reduce the jobless rate? Nevertheless, it’s apparent that the majority of the FOMC believes that doing something is better than doing nothing at all in the current economic environment, and that such a policy initiative will keep financial conditions easier than they might otherwise be. In addition, with the Federal Reserve forecasting inflation to decline as we enter into 2012, the FMOC also believes the costs of such unorthodox action are relatively low.
It should be stressed that Operation Twist is not the third round of quantitative easing (QE3). For quantitative easing to be initiated a central bank needs to buy financial assets in order to inject a pre-determined amount of money into the economy. Operation Twist doesn’t introduce an additional quantity of money into the economy as bonds of shorter maturities are being exchanged by the Federal Reserve for those of a longer maturity. Essentially bonds are being swapped – so no additional money is being created. Indeed, the Republican Party would find any additional quantitative easing politically unpalatable as this would boost the size of the central bank’s balance sheet – unacceptable to both Republicans and their Tea Party allies.
From here investment markets are likely to take some comfort from Operation Twist as ten-year bond yields are likely to remain at least 10-20 basis points below where they might ordinarily have been had the FOMC not taken this unorthodox policy. Both the size and longevity of Operation Twist implies monthly purchases of $50 bn until the end of June 2012, which at least removes a degree of uncertainty from the short-term outlook. And finally, the extension of the average maturity of the Federal Reserve’s portfolio coupled with the decision to purchase MBS (mortgage backed securities) should at least provide some support to the beleaguered US housing market.