x Abu Dhabi, UAEMonday 22 January 2018

New highs await markets as monetary easing continues

The existing trend of cheap liquidity and over-inflated equity markets will continue to push markets to newer highs through the end of this year.

Global financial markets notched up a stellar performance in October across major financial centres as stock markets marched to all-time highs.

The United States S&P 500 index and the benchmark German DAX index posted new record highs, while the Dow Jones Industrial Average, and the Sensex in Mumbai, closed the month just under their respective all-time highs. The FTSE traded near its highest level since the turn of the century.

Benefiting from the improved sentiment, financial markets have been rekindled with the risk-on mood following the successful re-opening of the US government and the raising of the debt ceiling.

The extended monetary policies of global central banks have propped up markets while the delay in the US Federal Reserve’s taper has resulted in the safe haven US dollar slumping – the US Dollar Index, a measure of the value of the greenback relative to a basket of foreign currencies, trades near lows this year.

However, these gains come amid rather precarious economic circumstances. Global growth forecasts remain gloomy: in its most recent World Economic Outlook, the IMF forecast that global growth would cool to 2.9 per cent this year, compared with 3.2 per cent last year.

Global employment conditions also remain anaemic, with emerging markets plagued by inflationary concerns as their governments struggle to manage their budgets and rein in deficits.

Despite deteriorating economic data from all corners of the globe, we see resilient stock markets, thanks to the aggressive monetary policies of the world’s most powerful central banks.

The current status quo dictates that weaker economic data equates to continued easing, leading to inflated equity markets.

This effect was best showcased in the market’s reaction after September’s delayed US non-farm payrolls (NFP) report. The NFP report is regarded as the godfather of data across the global economic calendar – no single piece of data affects markets as directly in the short term or shapes market sentiment in the longer term.

The report confirmed the abysmal condition of the US labour market – a meagre 148,000 new jobs were added, well below the 12-month average of 185,000.

The US Dollar Index shed half a per cent following the release, while the S&P 500 index hit an all-time high of 1,772 the week after.

The condition of the US labour market has been the main gauge for determining when the taper will start.

The Federal Reserve has been using the overall unemployment rate as its benchmark for determining its future monetary policy. It has also maintained that unemployment must fall below 7 per cent to consider the taper, or the start of its proposed scaling back of the existing monetary easing programme.

The unemployment rate in September may have fallen to 7.2 per cent, but this was on the back of a shrinking labour force – the figure was misconstrued as a result of the falling participation rate. Some 312,000 people left the labour force, dropping the participation rate to its lowest level since 1978 at 63.2 per cent.

With September’s figures now in the book, two things have become clearer – the US is not creating enough jobs and there will be no Fed taper before the end of the first quarter next year.

This was confirmed at the conclusion of the Fed’s most recent meetings when it maintained that the existing US$85 billion a month easing plans were set to continue as it awaits more evidence that progress will be sustained before adjusting the pace of its purchases.

With one more round of Fed meetings in December, along with my expectations of an average of 150,000 jobs being added in the last quarter of 2013, it’s unlikely that the taper will start until next year.

With this view, the existing trend of cheap liquidity and over-inflated equity markets will continue to nurture the current risk-on sentiment and push global financial markets to newer highs through the end of this year.

Gaurav Kashyap is the head of futures at Alpari ME