The autumn of 2013 is seeing central bank and political news having a significant influence on market sentiment.
We still have to overcome several more events, not least the US debt ceiling in October, but the final weeks of September saw three “surprises” that have removed some short-term risks.
First, we have seen a diplomatic agreement on Syria. This has removed the threat of near-term action by the US, solves a foreign policy headache for Western leaders and has taken a big potential concern off the agenda for investors.
The second big news was the withdrawal of Larry Summers running for the role of chair of the Federal Reserve replacing Ben Bernanke in January 2014. His candidacy caused significant political divisions. Given his nomination looked unlikely to be approved by Congress, he withdrew before even being nominated. As a result, the current vice-chair of the Fed, Janet Yellen, looks likely to be put forward.
The biggest news saw the Fed maintaining the status quo with regard to quantitative easing (QE). It would appear that the Fed is not convinced that the pick-up in economic data can be sustained and that some of the numbers within the unemployment data remain unsatisfactory.
The unemployment rate has fallen over the summer to 7.3 per cent, but this has been driven by falls in the participation rate (the number of people actively working or seeking work) rather than a rise in employment. What is clear is that the Fed is looking very closely at the macroeconomic data and it is not satisfied with its findings.
For example, mortgage rates in the US have risen significantly since the first talk of tapering back in May and this is a de-facto rate tightening – certainly not what the Fed wanted, particularly given the importance of housing to the wider recovery.
It appears that the Fed does not believe that the US economy and, specifically, markets are yet able to wean themselves off the central bank largesse that has driven returns over recent years.
It is worth noting that the S&P 500 index has had a 90 per cent correlation with the direction of the Fed balance sheet since the financial crisis. The Fed does not want a huge sell-off in risk assets as it will impact wealth and sentiment, and it seems the Fed does not believe that economic growth is strong or sustainable enough yet to support asset prices.
Hence tapering is postponed for now. Low inflation, a slowly recovering labour market and a housing recovery that remains sensitive to rates suggests that US monetary policy will remain accommodative in the medium term, particularly if Ms Yellen is leading the Fed.
Our views as October begins are more positive than in early September, but we still have hurdles to overcome. But the continuation of QE and a Fed under Ms Yellen would create a stronger backdrop for risk assets; and if we have no surprises on the downside from the newsflow and the economic data continues to improve, we should see markets make decent progress.
