O-B-Y or the three bets for 2016: Oil Brexit Yen
The 6% correction in the pound sterling over the last ten days has boosted British blue chips, which have gained 17.5% since January 1, 2016, twice as much as the US S&P 500 and Dow Jones indices (7%) and three times as much as the MSCI World index (5%). European indices remain in negative territory (-1% for the CAC40 and DAX, -4% for the Stoxx600 and -20% for the Italian FTSE MIB index) with earnings growth still flat or even negative. Beyond Brexit, the two drivers of global markets continue to be a lower-than-expected normalization of Fed rates and the evolution of oil prices, with the appreciation of the US dollar as the point of convergence.
The recovery in commodity prices (+10%, including +42% for Brent crude) boosted the performance of the MSCI Emerging Markets Index (+18%), driven in particular by the Brazilian index (+42%). In European markets, only the oil and gas sector posted a very significant performance (+12%). In the bond segment, US high-yield bonds offered a 16% gain, while emerging market bonds denominated in dollars posted solid performances (+14% for sovereign and corporate credit).
Finally, apart from oil and Brexit, the third bet of the year was on the yen, which gained 14% against the US dollar and 12% against the euro. At the beginning of the year, market participants were anticipating 120 yen to the dollar in 12 months, compared with 103 currently. This is despite major unconventional monetary announcements: for example, the Bank of Japan lowered its deposit rate into negative territory in January and innovated in September with an innovative yield curve control policy on 10-year maturities (YCC policy). The political calendar in the United States (US elections) and Europe (Italian referendum, French pre-elections, hard Brexit) does not appear likely to reverse the trends of the last six months.
A new challenge for central banks: reviving short-term credit to stimulate investment in innovation
Another development in discussions over the past few months concerns the concerns of investors, and then central banks, about the exit from unconventional monetary measures. Falling bond yields, flattening yield curves, and weaker performance in the banking sector have made it necessary to adopt new measures to offset the effect of asset purchase programs. The first solution was to provide liquidity at zero or even negative rates, in proportion to the volume of credit granted to businesses and households, contributing to improved profitability, as mentioned in the Bank Lending Survey. This measure was designed to offset negative rates. This is the case for the European Central Bank.
A second solution was to target a long-term yield on sovereign bonds in order to better control the risks of a flattening yield curve. This measure was designed to offset, among other things, the negative effect of the Central Bank’s excessive holdings of sovereign debt on sovereign bond yields.This is the case for the Bank of Japan.
A major issue is currently under debate: how can central banks contribute to increasing potential growth? One solution would be monetary policies that target short-term credit rates rather than long-term debt on the financial markets. These short-term operations would focus more on investments financing innovative projects led by smaller players, as opposed to large, well-established companies or governments, which can resort to longer-term debt (hence another debate: the extension of fiscal policies by governments made possible by favorable financial conditions).
It would therefore be advisable to target investment and innovation capital rather than capital already existing on the financial markets. The difficulty would thus be to pursue policies that target short-term rates more. Rates that are already low or even negative. In addition, greater emphasis on forward guidance by central banks would ensure stabilization or even a reduction in the risks associated with maturity transformation operations. This would encourage two types of investment. On the one hand, long-term investments financed by short-term borrowing. On the other hand, investments by riskier players that have the potential to bring about new innovations. A final point is that this has the negative effect of encouraging the financing of « bad » risks at the expense of « less » risky investments.
