10/05/2015 01:30 AST
Financial markets in the Gulf are showing a degree of divergence, as stocks have sustained an uptick, albeit tempered, while bonds have retreated as foretold, confirming that bubbles, originating abroad, do indeed burst.
In a world in which both mainstream asset classes have so conspicuously prospered in recent years, boosted by investors’ desperation for yield, that’s a relatively novel development.
Within the region there’s a certain, explanatory logic arising from rebounding oil prices, which drive liquidity and the earnings outlook of local corporates.
At the same time, it’s feasible in theory to argue that the revival of business momentum might make for an inflationary outlook, conceivably oil-related too, that would worry the fixed-income arena.
Yet, of course, the international backdrop is vital to understanding the drivers of these trends, and here the distinction in nature of equities on the one hand and bonds on the other is most informative, although a collective collapse is not infeasible.
For, while there is no necessary or at least immediate ceiling to the potential growth of the economy that might inhibit stocks and the payment of dividends, the bond market locomotive has hit the buffers, in terms of diminished yields and therefore limited further price advancement. Credit spreads will only be compressed so far by localised circumstances. Now it’s about the scale of the train wreck.
Most conspicuously, to the extent that core European benchmarks exhibit negative yields, the downside for prices inevitably loomed large, with knock-on effects internationally. The little leeway for capital gain depends then on a seller finding an even more desperate buyer, which could only go on for so long. Investor vertigo was unavoidable.
Fed monetary tightening
US Treasuries, meanwhile, providing a greater influence still across both developed and emerging markets, have tumbled as economic recovery has become a reality, particularly as regards employment data. And because, simply, the party music there is fading out.
Despite the Federal Reserve’s reluctance to hasten monetary tightening, market participants perceive well enough that it can be expected within the next year. A natural transmission of that step across the yield curve means that bonds are bound to react, and decisively so once a critical mass of belief has set in. In a dementedly crowded investment space, there can easily be panic in finding the exit.
Thus, while it’s perfectly possible in principle for stocks and bonds to move in tandem, notably when exchange-rate trends are the dominant factor, at present American financial markets show some parting of the ways in line with historical, cyclical rhythms, besides structural manipulation by the state.
We have not yet reached the point in this experience of quickening economic growth for the fiscal dimension to kick in, whereby reduced deficits would restrict supply. So it remains the demand story, of investors’ appetite for government debt per se in the current environment, that holds sway over sentiment, rippling across global markets. The markets have decided now to get ahead of the Fed’s pending decision. Anticipation is all.
In this respect, incidentally, a certain economic policy conundrum has existed, at least in the minds of commentators calling for yet greater government budget outlays to stimulate activity.
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