Tea leaves portend good market news
In an opinion piece in Business Day, Sasfin Securities strategist David Shapiro made the point that financial markets exist to make a mockery of forecasters, and that if you want to trash your reputation in this market, make a forecast (“The reputational risk of making forecasts,” May 7).
As a long-time reader of financial market “tea leaves” ,I am sad to say he is not wrong. In this business you are almost always wrong. I have found it more fruitful to try to discern how the moving parts relate to one another than to predict where they will eventually go.
The dominant question in financial markets now is how to process Biden fiscal transfers to US households. Does this again herald a reckoning with Fed tightening? Should we be bracing for a taper tantrum-like response by financial markets?
When we set expectations for the future, we tend to rely on history; the more recent the better. In the context of recent history, I argue this would be the wrong strategy. We might have to look a bit further back than the 2010s for clues on what could happen in financial markets, and thus our economy, in the months ahead.
When I started in markets, macro strategists and market watchers lived by the rule, “When the US sneezes, the world catches a cold”, premised on the understanding that the US dominated global demand, and that a slowing US implied a slowing globe. Growth was seen as the primary driver for investment returns. It was riskon when the US grew, and the reverse applied.
In fact, the US Federal Reserve hiked 4.25 percentage points from 2004 to 2006, and industrial commodity prices rose more than 70% from when the Fed started hiking to their peak in 2008. SA’s GDP growth accelerated while the Fed was tightening. Emerging-market equities gained throughout the period. Investment in emerging market equities stayed robust.
After 2010, US monetary policy trumped growth as the de facto primary driver of financial market flows and dominated returns. Who remembers the “Fed put” and the “don’t fight the Fed mantra”? At its most advantageous, this
phenomenon saw record levels of cash flow into emerging markets and other risky assets in 2011 to 2012 as commodity prices softened and the global growth outlook dimmed.
The worst came during the taper tantrum in 2013, when talk of reduction in Fed asset purchases led to a painful adjustment in borrowing costs and tightening financial conditions, which resulted in an abrupt reversal of flows out of emerging markets.
The ghost of the taper tantrum haunts financial markets to this day. This, together with the recent experience of the market selling off on expectations of Donald Trump’s fiscal stimulus at the end of 2016, informs concerns that capital could flow out of emerging markets soon.
I suspect we are in an era again where better US growth is good for risky assets. If markets were going to sell off in response to US fiscal stimulus they would have done so already. Arguably, the February sell-off was the full extent of it, so it is, in a sense, behind us.
Also important is that the 2016 fiscal expansion came when the US was already at full employment and thus had more hawkish implications for the Fed than the current stimulus. So I would not worry too much about the effect of the Biden money drop on the Fed and financial conditions for now.
Commodity prices will continue to benefit from demand improving without being disturbed by the Fed. This should continue to support domestic terms of trade and shore up the rand. This will remove pressure from the Reserve Bank, and rates can remain lower for longer. SA looks set for continuing improvements in economic outlook, a welcome reprieve.
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