A mug’s game worth playing

Investors have to watch the central banks

It used to be generally accepted that trying to predict the actions of central bankers was a mug’s game.

Yes, there were always those wonky few who spent their days reading the tea leaves of Federal Open Market Committee meeting notes and parsing the utterances of Ben Bernanke and the gang. But really, who else could really be bothered?

Well, these days, post-2008, everybody’s doing it, and they kind of have to because what’s happening in the hallowed halls of the world’s central banks is a driving factor in the markets’ recent ups and downs.

Earlier this week, two events — one eminently predictable, the other seemingly out of left field — showed just how correlated the markets are to the monetary policy environment.

On Monday, the European Central Bank initiated its previously announced but unprecedentedly large bondbuying program to the tune of €60 billion ($80 billion) a month.

The impact of the ECB’s easing on fixed-income markets was clear and immediate: yields on eurozone bonds dropped to record lows. By Tuesday, the yield on 10year government bonds fell to 0.23% in Germany, 0.52% in France and 1.21% in Italy, according to Bloomberg.

Yes, Italy, where the ratio of government debt to GDP is nearly 150%, according to the Organization for Economic Co-operation and Development, and which had its credit rating cut by Standard & Poor’s to BBB last December — one notch above junk.

By comparison, yields on 10-year U.S. treasuries on Tuesday stood at 2.13%.

If an alien with a basic knowledge of risk and return landed on Earth and took a quick look around, he might figure that the United States is a more dangerous place for his Martian tanpis than Italy is. This is the topsy-turvy world we’ve created.

And if you could do 92 basis points better by buying into the world’s strongest economy than Italy, or for that matter 60 points better than Canada, which recently cut rates, heck, where would you put your money?

Small wonder the euro is at a 12-year low against the greenback, closing Tuesday at US$1.07. Or that the loonie dipped below US79¢.

Meanwhile, half a world away from ECB headquarters in Frankfurt, Richard Fisher, the outgoing president of the Dallas Federal Reserve Bank, gave a farewell speech in Texas and opined that the Fed should adopt a bias to raising rates sooner rather than later, citing strong jobs data that indicated the U.S. economy is nearing the central bank’s definition of full employment.

Fisher has long been considered one of the more outspoken Fed hawks on interest rates, but the markets apparently took his utterances seriously, as yet another signal that U.S. rates would rise more quickly than some prognosticators had assumed, or at least that a potential hike in June was closer to reality.

As a result, the greenback rose against other currencies and stock markets cooled as investors factored in the impact of a rate hike and a still-soaring U.S. dollar.

The S&P 500 gave back all of its 2015 gains on Tuesday, and the Canadian S&P/TSX composite index closed at its lowest level since Jan. 29.

Now, it could well be that these market moves are an overreaction to the risk of a U.S. rate hike since Fed chair Janet Yellen might still have good reasons to delay tightening.

One is that despite strong job growth — the U.S. economy surprised on the upside with 295,000 job gains in January — wage growth looks a little weak. That wouldn’t matter so much if you were, say, China, but consumer spending comprises twothirds of U.S. economy.

Inflation, meanwhile, remains well below the Fed’s target of 2%, and the spectre of deflation hasn’t disappeared.

And then there’s the nagging problem of the currency, which is already hurting U.S. corporate profits, and which would get another boost if the U.S. hiked rates.

All eyes, obviously, will be on the Fed meeting next week, and the markets will carefully parse every word. (Watch to see whether “patient” gets dropped from the comments or not.)

Monetary policy-makers are jumping through hoops to deal with the problem of growth, both positive and negative, and markets are scrambling to figure out what to make of it.

While they do, investors can expect more dramatic currency fluctuations and market shifts.

But if Yellen can pull off the balancing act of not derailing the economic recovery, bringing back some modicum of monetary normalcy and managing market expectations, then she deserves a spot in the Cirque du Soleil.