Economic and asset allocation views covering Q2 2014
14 April 2014
The first quarter of the year saw an increase in volatility with equity markets struggling to gain momentum whilst sovereign bond markets rallied. Some of the strongest bond market gains were seen in peripheral Europe where the tail risk of a Euro break-up and the trials and tribulations of Greece appeared to fade from investors’ memory. Today, markets are more preoccupied with the slowdown in emerging markets and the tail risk of a hard landing in China. The crisis which began in the US in 2007 has travelled, via the Eurozone, to the developing economies.
Alongside changing perceptions of tail risk, there was a growing sense that central banks were becoming less supportive of financial markets.
Alongside changing perceptions of tail risk, there was a growing sense that central banks were becoming less supportive of financial markets. Members of the Federal Reserve (Fed) policy making committee have cited excess risk in markets as a concern and it would seem the committee believes that QE is becoming exhausted as a policy tool in the US. The decision to continue tapering in the face of a weakening in the economy reflected these considerations and the Fed has signalled that it will be moving to forward guidance as a means of influencing market expectations for interest rates in the future. Meanwhile, in the Eurozone investors have been concerned about the lack of European Central Bank (ECB) reaction to very low inflation and the risk of deflation, whilst in Japan the central bank has been unwilling to act preemptively to head off the effect of the increase in consumption tax. We expect that the Bank of Japan and ECB will prove more flexible in coming months, but that the Fed will continue to taper and move toward interest rate increases.
In this Perspective, we assess these factors and report our latest asset allocation views. We also update our long term projections for asset class returns and re-visit the relationship between the economic and market cycles.
Keith Wade, Chief Economist and Strategist, Schroders
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