Panic over, but what's next for markets?

Having recovered their composure after a tumultuous start to 2016, investors are now looking for a new catalyst, but what will it be and where next for markets?

6 April 2016

Keith Wade

Keith Wade

Chief Economist & Strategist

Markets have regained their risk appetite following action by central banks, a firming in commodity prices and evidence that the tail risks of a US recession or a China hard landing are not materialising.

Going forward we will need to see greater evidence of stronger activity for the rally to continue; however, this is also likely to bring the Federal Reserve (Fed) back into play, posing a challenge for investors.

Why have markets rebounded?

After hitting the panic button in January, investors have regained some composure: shares and corporate bonds have rallied whilst the risk appetite index has moved out of panic mode.

Arguably, the market simply became oversold and was due a bounce, but the key macro factors underlying this were the actions of central banks and firmer economic data, which have reduced the tail risks facing the world economy.

This may carry assets higher from here, but for a sustained improvement we need to see better growth in real GDP and corporate earnings.

The tail risks have eased, but has the outlook brightened?

At this stage, it is difficult to make the case for an acceleration in real GDP growth.

Our indicators point to steady but not spectacular growth, a continuation of the pattern of recent years where the world economy struggles to get growth much above 2.5%.

However, the Fed is still expected to lift rates - twice this year in our view - raising the prospect of further dollar strength and renewed market volatility.

It is possible that, as we have just seen, the selloff in markets then drives the Fed back and it stays on hold. Markets could then rally again.

However, this is not sustainable given the very low level of US interest rates and the late stage of the economic cycle.

Could we be surprised on the upside?

There are scenarios where growth is stronger than expected. One would be where the lags from the fall in oil prices continue to feed through and support consumer spending.

It should not be forgotten that the lags are long and consumers take time to recognise when a change is permanent rather than temporary.

We have also noted that the savings rate in the US remains high and whilst this might be a permanent feature of the post-crisis world, the improvement in wealth suggests that consumption could get a boost from lower savings in 2016.

Another scenario would be an improvement in productivity. At this stage this looks unlikely, given the weakness of capital investment spending, and so, as we have argued before, we may have to wait until governments recognise that monetary policy has run its course and other means of stimulus need to be deployed.

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