US monetary policy will remain laxist, tapering or no tapering ………..
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Benjamin Melman – Head of Asset Allocation and Sovereign Debt
Against a backdrop of mostly unsurprising third quarter results in the US and Europe and stable economic data, equity markets remained in bullish mood in November. We are maintaining our positive stance on equities, notably in Europe, for two main reasons: first, we believe US growth will soon accelerate and have a positive impact on Europe and, second, sweeping disinflation in developed countries will force central banks to stick with their very accommodating stance.
Ebbing inflation has taken all central banks by surprise and they now know they must vigorously fight against deflation. This is why the ECB cut its interest rates by 25bp earlier than expected and why it has maintained a very pro-active tone. Even so, markets will want to see how the Federal Reserve acts and so tapering talk will take centre stage in coming weeks. The situation is rather confused due to the split between the Fed’s latest minutes, which said that
tapering should start in the near future, and Janet Yellen’s insistence that the economy’s current weakness means sticking with the same monetary policy until further notice.
To date, Fed discussions on how to convince markets that no rate rise is planned in the short term seem to have made so much progress that there is no doubt that monetary policy will remain laxist, tapering or no tapering.
Nevertheless, tapering, when it finally starts, could trigger short term market volatility but we do not think the Fed will act at its next monetary policy meeting on December 18. It would be dangerous to take this risk during a period of low market liquidity especially as there is no hurry.
In coming weeks, risk assets could therefore be hit by bond market volatility.
We have accordingly maintained our bearish view on US bonds and have started this month to reduce exposure to European bonds. We are, however, still keen on high yield bonds and convertibles.
The divergence between the Fed and the ECB is becoming clearer all the time.
The Fed is working towards normalising monetary policy, even if this will be very slow and probably late, while the ECB is more concerned with finding novel ways of fighting deflationary risk. In our view, this difference of approach is good news for the dollar and we are maintaining our positive view.