LIQUIDITY provides the cushion for risk appetite; remove it, or at least the promise of more of it, and asset classes deemed riskier, such as stocks, are automatically put in a spot of bother.
That’s what the latest minutes from the US Federal Open Meeting Committee, released after our markets closed on Wednesday, did. It’s the threat that the dollar may become a bit more expensive — and much sooner than 2015, when the Federal Reserve sees monetary policy normalising.
According to notes from the meeting, which took place towards the end of last month, some members of the Washington-based bank have raised concern over the cost and risk of more asset purchases.
In an unprecedented effort at boosting the US economy and job growth, the Fed buys securities at a pace of $85bn a month. Its balance sheet is more than $3-trillion and if it continues for the rest of the year, could increase to $4-trillion.
The growing unease in the Fed means the policy is under threat even before it reaches the required level of job growth. Just the fact that the bank is debating its open-ended policy has seen a huge sell-off in the markets.
It says a lot about the "flimsy" foundations of the markets, according to independent analyst Ian Cruickshanks.
Appetite for risk has been supported by cheap dollars, hence oil prices have risen to levels seen before the 2008 recession, despite demand from the global economy still being sluggish.
If the US Fed stops the printing presses, asset prices should in theory start to reflect the state of the global economy, and more specifically the health of the US economy, as New York is the price setter.
(Companies with the biggest weighting on the JSE, much like those on the London Stock Exchange, are very diversified and so aren’t as shaped by domestic woes.)
As concerns still remain over the health of these economies and Europe’s, an end sooner than expected to US stimulus measures will bring us to a better reflection of the value of assets. As fragile as we are, I suspect it won’t make for comfortable reading.
In the short term, an end to the Fed’s quantitative easing would be negative for stocks, commodity prices and those investors who piled into bond markets for their "safe-haven" status. If evidence emerges of an improving global economy, the sell-off may be short-lived; if not, expect the opposite.
Markets are just reacting to this possibility; it’s future scenarios playing themselves out.
There has been no change to policy decisions from the US, just news that there is growing debate against current policy.
"At the moment, it’s too soon to panic," Cruickshanks says. The real test comes next week, when Fed chairman Ben Bernanke testifies to the Senate banking committee.
Given that hawkish views are gaining traction across the market, the onus will be on the chairman to make a strong case for continued Fed accommodation. Can the US afford a stronger dollar? It’s not beneficial if you’re trying to trade your economy out of trouble.
If Bernanke’s testimony does anything but reassure that things will continue for a while still, what we’ve seen in the markets this week will just be the tip of the iceberg.
The JSE all-share index dipped below 40,000 points for the first time since late last year and had its biggest one-day fall since April as local and international markets reacted to the threat of a premature end to stimulus.
The index is only 0.9% stronger this year — after strengthening more than 4% in the first week this month — as investors press the sell button for equities across the globe. But one has to bear in mind that the local market has rallied more than 16% in the past 12 months.
There was blood right across European markets as well, with London’s FTSE 100 slipping below 6,300 points after trading as high as 6,400 this week.
Commodity prices all came under pressure. Gold, probably the biggest beneficiary of Fed action to date, drifted between gains and losses during the day. Keeping gold from following other currencies weaker was probably Chinese concern over its property markets being the positive factor for bullion.
The world’s second-biggest economy called on local authorities to curb real-estate speculation and rein in the property market.
Among emerging market currencies, the rand was actually among the better performers on Thursday. East European currencies such as the Hungarian forint and the Polish zloty came under the most pressure.
This week saw the markets’ response to the threat; next week Bernanke may ease those concerns and spark a relief rally — anything else seems unlikely.