Ben Bernanke, the Federal Reserve chairman, confirmed on Monday what investors had been fearing – that the US central bank might keep tightening monetary policy in spite of recent weak economic data. The odds on a rate rise at this month’s meeting moved from 50 per cent to 84 per cent.
Ten-year Treasury bond yields dipped below 5 per cent on Friday but moved higher again over the past two days in the face of competition from potentially higher short rates. The dollar rebounded a bit on the back of Mr Bernanke’s comments but it is hard to see it making much progress if investors start to worry about US economic growth.
Investor sentiment has not been helped by the stubborn refusal of the oil price to drop decisively below $70 a barrel, with threats of a supply disruption by Iran the latest factor to squeeze crude higher.
Clearly, uncertainty over the Fed has played a big part in recent market moves. “Bernanke’s attempts to be more transparent and data-dependent has led to greater, rather than lesser, market volatility,” says Fredrik Nerbrand, investment strategist at HSBC Private Bank.
It would be excessive to say that investors are worried about stagflation but they do seem to fear a worse trade-off between growth and inflation. “Inflation fears have suddenly morphed into a growth scare,” says Richard Berner of Morgan Stanley. “In our view it’s too soon to sound the all-clear on cyclical inflation risks. But we believe the growth scare for now will prove to be just that – a scare.” In contrast, Graham Turner of GFC Economics says: “It is not the threat of higher inflation that is undermining equity markets but the risks of monetary overkill.”
It may yet be that the deeper reason for the turmoil is a decline in liquidity. When the Bank of Japan announced it was set to end quantitative easing, there was a mini-wobble covering markets such as Iceland. Since then, the yen has strengthened against the dollar, penalising investors who had borrowed yen as part of a “carry trade” into higher-yielding assets. It seems likely many carry trade investors will have been forced to cut their positions, fuelling volatility.