What does reversal of central bank intervention mean for credit markets?
Global credit markets are at a crucial juncture amid very low yields and higher inflation, with central banks now walking a tightrope as they attempt to unwind policies without causing volatility to jump, Kames Capital’s Adrian Hull says.
Following a prolonged period of ‘hyper-proactivity’ from central banks, during which time they have done their utmost to combat deflation and low or negative growth via quantitative easing and record low rates, the onus is now on them to deliver a reversal of such policies.
However, as central banks begin this process, Hull, co-head of fixed income at Kames, warns any deviation from a steady unwind of global central bank policy could have a major impact on fixed income markets.
“For the past half dozen years central banks have been hyper-proactive in support of monetary policy,” he says.
“It is desirable that central banks’ balance sheets are now seen to be normalising, but the pace is likely to be benign. The point here is that the rates markets expect an orderly removal of stimulus over a long period of time, with that orderly process captured in current market valuations. A disruption to “orderly” is likely to cause meaningful market volatility and back up valuations.”
Hull says currently valuations across fixed income markets reflect the belief that central bankers will be able to unwind policy in a managed and effective way.
He notes US Treasuries – as a shorthand measure of global interest rates – still remain at very low yields, despite higher inflation, improving PMI data, and higher GDP growth. The expected “Trump reflation” has not proved to be a story for 2017.
But he warns the current environment is fraught with risks, not least because valuations are elevated.
“Central bankers are pilots frantically tapping their instrument gauges – they know they will need to land but they have to do it on their own and need to negotiate the crosswinds of investor sentiment,” he says.
“Investor concerns continue to be that headline prices offer little room for manoeuvre and that central bankers could fail to deliver a safe landing; current pricing remains benign – any change to this outcome could send a chill wind to the bond market.”