Although the past month has been generally quiet, there has been a definite sense of fragility. The looming spectre preying on investors’ nerves is the possibility that the US Federal Reserve could start tapering off its quantitative easing (QE) programme.
It is currently buying $85bn (£54.1bn) worth of government-backed bonds every month to stimulate the economy and keep the cost of borrowing down.
After a number of statements from the Fed chairman Ben Bernanke, the consensus among investors is that tapering could start before the end of this month. Others think December is more likely, but they are resigned to the fact that it will happen all the same.
When QE tapering begins, the biggest casualties are likely to be the emerging markets that have failed to put their cheap money to work and are now facing the consequences in the form of downward pressure on their currencies and increasing costs for all their debt. The concept of ‘decoupling’ has turned out to be a non-starter – emerging markets are dependent on developed markets.
Step forward India and Brazil, which have found themselves extremely vulnerable to any changes in US fiscal policy and are now bearing the brunt of the speculation about QE, with Indonesia and Turkey also suffering.
China, in spite of negative sentiment, has held up well, as has Russia. Their strength could distort emerging market indices.
Emerging markets may be less vulnerable than they were in previous crises, but countries without a strong domestic investor base are going to struggle as the developed world takes its foot off the gas.
Although there are some attractive opportunities in some of the emerging markets – or, more specifically, some of the ‘frontier’ markets – the current headwinds will send prices even lower
The Bank of England’s new governor, Mark Carney, has taken a lead from the US by adopting the concept of forward guidance, giving investors reassurance that interest rates will stay low for some time.
He has also put forward similar caveats as the Federal Reserve, saying any changes in fiscal policy will depend on what happens to unemployment and inflation figures. Growth expectations for the UK have been revised upwards, but while some growth is clearly good to see, the figures themselves are still quite anaemic.
Bond markets remain a concern and it isn’t possible to draw any real conclusions about them at the moment given the levels of manipulation involved in QE.
With government debt, bonds with shorter durations, typically two to six years, have been the favourite as a way of reducing risk. However, there are those who believe they are safer with longer durations.
Oliver Wallin is investment director at Octopus
