Friday 27th August, 2021
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Most markets have been in recovery mode this week, following a period of consolidation amid concerns about the economic impact of (gradual but increasingly imminent) monetary stimulus withdrawal in the US, the spread of the Delta variant around the world, and China’s punitive crackdown on its fast-growing technology sector. Given their sensitivity to economic activity, cyclical assets and commodities bore the brunt of the sell-off last week. Hardest hit were energy prices, with WTI (-8.9%) and Brent (-7.7%) both experiencing their worst weekly performances so far this year. Copper (-5.8%) also faced heavy selling pressure through the week given its widespread use in manufacturing and construction. Nevertheless, sentiment has since improved, and last week’s laggards have turned into this week’s winners. Perhaps unsurprisingly, emerging markets have seen the largest V-shape move in equities, with the MSCI EM Index up +3.7% (in USD) over the first four days of the week following a -4.7% fall last week. But the S&P 500 Index and the Euro STOXX 600 Index have also swung about in similar fashion.
This shallow-correction-rapid-recovery move in the past two weeks fits a routine pattern of price action in equities and real assets that seems to have become established this year. There have been repeated wobbles caused by lingering anxieties about the pandemic, the state of the world economy (now and in the post-covid-19 future), and frothy prices in many markets. However, any downwards moves tend to rapidly reverse as investors fall back on the abundant liquidity support provided by central banks – and the widespread TINA mantra (that ‘there is no alternative’) given the paucity of yields and spreads on offer in fixed income. In such an environment, the best strategy has been to stay invested but diversified, ride the unavoidable volatility, and buy big dips when they come. Spending money on equity hedges is pointless when the Fed backstop is behaving as one giant put option already!
The most anticipated event of the week – and the one most likely to cause a stir among investors if Fed Chair Jerome Powell does not stick to his July FOMC script on rates and QE tapering – the Jackson Hole symposium of US central bankers is taking place as we go to print. The annual event is an opportunity for Fed officials to share their forecasts and views on growth and productivity, monetary and prudential policy, and (normally) the charming Wyoming countryside. This year, however, the event will be held virtually given the huge rise in covid-19 cases over the summer. America now has the highest number of people in hospital with the disease since January (>100K at the last count), and this grim tally will not be far from Powell’s mind when he assesses when (and how quickly) the bank should slow its giant asset purchase programme.
We heard from a number of the (typically) more hawkish officials on Thursday, including Kansas Fed President George, Dallas Fed President Kaplan, and St Louis Fed President Bullard. The former two presidents argued that QE tapering should begin before the end of 2021 (Kaplan also said that he was in favour of starting the process immediately after the next FOMC ends on 22nd September). Bullard, meanwhile, wants the whole thing wrapped up before the end of Q1 2022. These officials downplayed the risks to growth from Delta, and they stressed that the economy is increasingly able to cope with the ebb and flow of coronavirus cases. Instead, they commented that the surge in consumer price inflation has been a lot more persistent and powerful than had been expected earlier in the year, and that labour market conditions have tightened very considerably as well. In their view, this means that now is the time to begin stimulus withdrawal.
Powell is typically on the more dovish end of the monetary policy spectrum, and he has regularly argued that pricing pressures will prove temporary. In his comments today, he did acknowledge that the inflation figures have been higher than anticipated, but again said that most of the increase can be attributed to transitory factors. He also stated that moving too soon would be a serious error, and he sought to dispel the idea that tapering its asset purchase programme means that the Fed will soon hike interest rates. Risk assets have rallied in response to his comments while the dollar has softened. Another Fed freebie as we head into the dying days of summer!
Sadly, there is much less to be cheerful about in Afghanistan this week. Following the deal that Trump made with the Taliban last year, the situation has sharply deteriorated for Ashraf Ghani’s democratically elected government. And President Biden’s decision to press ahead with such a rapid US withdrawal has pulled the rug out from underneath them. Preposterously, the Afghan government was excluded from the US-Taliban peace deal, sending an obvious signal to the militants and the Afghan army who were expected to fight them that America was in full retreat. It now looks like many of those who assisted coalition forces in their 20-year campaign will be left at the mercy of their former enemies. Having fought for two decades to win the war against the US led coalition and their Afghan government, the Taliban has few incentives to seek revenge immediately (although there are many reports of extrajudicial killings in the provinces). However, a large degree of pessimism about the country’s future is justified. There has already been a deadly terrorist attack against US forces and allies in the country (albeit claimed by ISIS), and Afghanistan could yet slip into a bloody civil war. If there is a second 9/11, Biden will be hung out to dry. Rivals China and Russia are making hay out of the debacle and have pointed out that the US is a fickle ally without the resolve to see missions through to the end. After Trump’s isolationism, Biden’s foreign policy may be reinforcing this perception from Eastern Europe to the South China Sea.
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