The Strategist

Fed’s policy induces new market rally

06/24/2019 - 11:45

Readiness of the US Federal Reserve to soften monetary policy once again and begin to reverse the rate cuts caused a rally in global markets, including oil prices (Brent quotes has risen by almost 5% since Wednesday). The demand grew for both risk-free and risky assets. For the first time since 2016, the required yield on ten-year US government bonds fell below 2%, while the total volume of bonds with negative returns rose to a record $ 12.5 trillion (in particular, German and Swiss government securities). The average yield on bonds is now only 1.76% against 2.51% in last November.

Billie Grace Ward
Billie Grace Ward
Recall, most of the participants in the Fed open market committee still do not expect rate changes this year. At the same time, no one predicted a decline in March, but now there are 7 out of 17 those who believe in it. In 2020, most of those surveyed predict a one-time rate reduction, although it was expected to increase once in March. Meanwhile, markets are counting in two rate cuts before the end of this year, with a 70 percent probability of a first cut already in July. Regarding the European Central Bank (ECB), the markets are also counting in a 10-basis-point deposit rate reduction with a probability of 85% (last week, Head of the bank, Mario Draghi, announced his readiness to soften policies).

"Following the Fed and the ECB, many central banks in developing countries can move to mitigation in order to prevent a threat to exports," said the Institute of International Finance. “Of course, the new easing will support business activity, but another period of low interest rates increases the risk of financial instability,” the institute notes, indicating that so far investors are counting on long-term strengthening of the dollar. Also, stable low rates will lead to an additional gap between stock and bond yields and greater growth in the already high corporate sector debt burden: low stock price growth on the stock market reduces companies' motivation to place shares, while lower rates make bond placement more profitable. “Presence of a positive correlation between all assets carries a double risk in the event of a recession, since portfolio diversification will be of little use,” concludes Robert Carnell of ING Bank.