Betting on central bank support 'is a dangerous game for markets to be playing'

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For the first time in 2016, risk assets are enjoying a prolonged period in the sun.

Since late last week stocks, commodities and higher-yielding currencies have all moved higher, helping to recover some of the ground lost in the first two weeks of the year.

The bounce in risk assets has seen many analysts question whether the weakness seen at the start of the year was just a temporary blip, or merely a precursor to a prolonged period of financial market volatility in the year ahead.

Improved valuations, reasonable economic data and a bounce in sentiment from near-apocalyptic levels helped explain the recent rally. But analysts at ANZ believe that another factor likely contributed to resurgence in risk assets seen over recent sessions – heightened expectations for additional stimulus from the European Central Bank, the People’s Bank of China and the Bank of Japan.

“Markets have also taken kindly to the ECB’s signal of possible additional stimulus as soon as March,” wrote analysts at ANZ.

“Some are even speculating on the chance of further easing from the BoJ and China this week, and with the way the market has discounted the odds of Fed interest rate hikes this year, it looks as though many are also looking for a softer tone at this week’s Fed decision as well.”

They suggest that the recent price action reveals that “expectations for the central bank ‘put’ appear alive and well”, alluding to the notion that central banks – as they have done in the past during periods of heightened financial market volatility – will look to calm markets by talking up the prospect for even looser monetary conditions.

Analysts at the bank suggest this “is a dangerous game for markets to be playing”, pointing to past policy disappointments as reasons to remain cautious.

They explain:

The ECB showed last time that expectations can sometimes be difficult to meet. But there also remain some pretty big questions over the economic outlook that tweaks in central bank action arguably do little to address, and one could argue (given the extent of policy stimulus already delivered) that the marginal benefit of further central bank action is now pretty low. At some stage, particularly if real activity data are still hanging in there okay, some tough love is required, or at least it is time for others (fiscal policy) to step up to the plate.

In essence, providing policy surprises that can lift risk assets for more than a fleeting moment are becoming harder to deliver, and if they do, their effectiveness on the real economy is increasingly negligible given the scale of policy easing that has already been delivered.

The move is losing its potency, both to underpin risk assets and broader economic conditions.

Whatever trajectory the global economy takes in 2016 – be it an improvement in activity levels or a continuation of the trend seen in recent years – it’s understandable why analysts from the ANZ, and elsewhere, remain cautious towards the recent resurgence in investor risk appetite.

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