Will the Hunters Become the Haunted as Stock Markets Slump?

Transition was the word of last year as bickering between London and Brussels over the terms of Britain’s two-year departure from the EU dominated the headlines. Sadly, it seems even that minor deal is unravelling.

As with so many areas of policy, the brouhaha over Brexit meant that many observers were blind-sided by the real transition that has already started to dominate 2018: the shift from ever booming stock markets and record low interest rates towards a new, more uncertain financial market.

Standard & Poor’s 500-stock index fell more than 10% from its peak in late January. Equity markets in Britain, continental Europe and Asia saw similar falls, leading to headlines about trillions being wiped off the value of stocks (not that the media ever report about trillions being added).

While no one could claim credit for predicting the timing and scale of the fall, commentators were quick to see the causes in the rear-view mirror: rising wages in the US, the arrival of a Fed chairman with no background in monetary policy, and fears of sharper interest cuts to curb inflation caused by President Trump’s deficit-fuelling tax cuts provided good explanations.

The recent bounce back in many financial markets points to the conclusion that there is no need to panic about the multi-day successive falls in stock markets seen after the bankruptcy of Lehman Brothers 10 years ago this September.

The world economy is enjoying its first synchronised economy recovery since 2010 and its fairly basic macroeconomics to see stronger growth meaning rising employment and pay — and thus increases in inflation and interest rates.

However, the slump in stock markets and the rising in bond yields — the amount lenders charge governments and businesses to borrow for them — has removed a handy protection for the governments in both the US and the UK.

Since the start of his presidency in January 2017, Trump has been able to cite the 26% surge in the US stock market up to its 26 January 2018 peak as testament to his leadership skills while the almost identical 26% jump in the FTSE100 since the 2016 referendum vote has been ammunition for the Brexiteers.

Central banks must, therefore, ensure that their stances on monetary policy are consistent and that their messages are clear

Of course, what goes up can come down and with them falls the credibility of those who claimed credit for the rises in the first place. The hunters become the haunted. Perhaps the removal of this veneer of market approval for Trump-enomics and Brexit is the silver lining to the cloud.

While it does not seem likely that there will be further immediate sharp falls, the continued jaw-jaw between the White House and North Korea, the uncertainty over how Fed chairman Jerome Powell will react, and the threat of a no deal Brexit outcome all have the potential to deliver one-off shocks.

While 2018 will probably not see a cratering of the stock market — nuclear war between Trump and Kim Jong Un aside — it will see a huge increase in volatility. Markets will rise and fall as will borrowing costs.

The main driver will be monetary policy — not just whether banks raise interest rates but also the remarks they make. As a well-timed e-book from the Centre for Economic Policy Research points out, monetary policy increasingly became the art of managing expectations via effective communication strategies.

Central banks must, therefore, ensure that their stances on monetary policy are consistent and that their messages are clear. The difficulty for markets is that central bank communication typically provides information on many different subjects and at many levels, which makes it hard to decipher all the signals clearly. The current and future challenge for central banks is to ensure that they send signals as clearly as possible. It will be not easy.

At some point people will realise that the really important transition date will not be March 2019 when the UK “leaves” the UK, but June 2019 when central bank governor Mark Carney ends his term just as Brexit uncertainty will step up a gear.

More about the author

About the author

Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.

Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.

He is the author of Brilliant Economics and The Great Economists.

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