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Central Bank Policy Update
Sunday 29, October 2017

Central Bank Policy Update and the impact on your investments

MarianP

In this article, we take a look at the recent policy shifts by the European Central Bank, the Federal Reserve and the Bank of Jamaica as well as the implications for your investment decisions.   Recent improvements in developed economies suggest that investors should watch their emerging market investments carefully. Rising interest rates in the U.S. could lead to gradual fund outflows from emerging markets as the return differential between the two markets compresses. Fund outflows can lead to depreciation of the local currency (and in turn reduced capacity to service foreign currency debt), less access to financing for local corporates, more expensive borrowing rates for local households and corporates and a general decline in the prices of the bonds and equities within the economy. The high levels of liquidity in the global markets may reduce the negative impact of these forces due to the high demand for financial assets. Nevertheless, investors should ensure their emerging market exposure is short in duration and focused on growing / profitable companies which generate at least part of their revenue from foreign currency.

 

ECB policy: This week, the ECB announced that it would reduce its current €60 billion per month asset purchase program by €30 billion per month starting in January 2018. The program is expected to continue until September 2018 or beyond if necessary. This is in response to a modest economic recovery in the Eurozone and an uptick in metrics of underlying inflation. Real GDP increased by 0.7%, quarter on quarter, in the second quarter of 2017, and 0.6% in the first quarter. Euro area Harmonised Index of Consumer Prices (HICP) inflation remained unchanged at 1.5% in September vs. the ECB’s 2% target. The monetary policy stance of the Central Bank remains extremely accommodative and expansionary. Mario Draghi also indicated that interest rates would remain at their current level (deposit rate = -0.4% and main refinancing rate = 0%) until well past the end of the asset purchase program.    European stocks and bonds rallied on the news. The rally remains capped by the uncertainty surrounding the Catalan Independence Vote in Spain. European asset prices appear to have room to rally and any softness around the Catalan vote could be viewed as a buying opportunity.

 

Federal Reserve: A strong labour market, improving inflation indicators and a better than expected GDP outturn (3% for the 3rd quarter in 2017) are pushing U.S. equities and Treasury yields higher. The 10 year US Treasury reached its highest yield (2.45%) since March 2017.  All indicators point to a Federal Reserve rate hike of 25 basis points in December.  This has resulted in the softening of some bond prices- which trade as a spread to the Treasury. Investors should treat the U.S bond market with caution. Avoid long term debt and buy for yield. Capital appreciation is likely to be harder to find in the bond market.  A long position in equities or equity linked debt will prove to be most attractive in the long term.

 

Bank of Jamaica: Locally, the Bank of Jamaica’s benchmark interest rate remains at 5.25% and it recently reduced the overnight borrowing and lending rates to banks. This implies an accommodative stance and is usually employed to stimulate local currency lending and thereby the economy. Similarly, Treasury Bill yields have been declining. However, the persistent issuance of USD and JMD instruments appears to be reducing liquidity and sterilizing the impact of any expansionary efforts. The presence of a robust supply of USD in the market has led to an appreciation in the JMD. This could be a good opportunity to buy USD. Regardless of your objectives, we advise investors to hold their hard currency investments and seek local currency investments that will provide returns in excess of the historical trend of inflation and devaluation.

 

Marian Ross is an Assistant Vice President of Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

 

 

 

 

 

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