World Economy

Central Banks Need to Win Confidence

Janet Yellen (L) and Mario Draghi at the Jackson Hole economic symposium in Wyoming in late August.Janet Yellen (L) and Mario Draghi at the Jackson Hole economic symposium in Wyoming in late August.

Market contrarians continue to close out their short positions on stocks, bonds and risk currencies as buying supports market levels, record low bond yields and emerging market assets, CNBC reported.

But can central banks continue to win the confidence game and herd investors into riskier trades or will the credibility of ECB’s Mario Draghi, BoJ’s Haruhiko Kuroda, BoE’s Mark Carney and Fed’s Janet Yellen ultimately be tested, triggering a wave of negative sentiment that could wipe out this unloved rally?

As one market participant has put it: The central banks are now more risk-loving than ordinary lenders. This is an extraordinary call, given central bank chiefs were forced to mop up the mess of the financial crisis triggered by the leverage created by the banks.

Scott Thiel, deputy chief investment officer of fixed income at Blackrock, acknowledged that it was an interesting thought in light of the European Central Bank’s corporate bond-buying program, which carries the risk of single issuer exposure.

But some are warning that the crunch point is coming. Fasanara Capital’s Francesco Filia said that on one hand, quantitative easing was useful to avoid a short circuit and create animal spirits. But on the other—because QE affects return expectations on all asset classes, killing savers, making them feel poor, increasing saving propensity over consumption and investment—”we are running the risk of becoming disinflationary”.

“QE is joined by fiscal policy or helicopter money or it runs the risk of being discontinued altogether,” he told CNBC.

Which raises the question, have investors all been directed into a pen for slaughter?

Thomas Moore, Investment Director of UK larger companies at Standard Life Investments predicted a snap back on the valuations of the companies he covers after a post-Brexit rally in the FTSE 100.

  Traditional Safe Havens

“Not only is the gap between equity yields and bond yields extreme, sector valuations are also at extreme levels, as is the gap between cyclicals and defensive valuations which is higher even than 2008-09,” he told CNBC.

Central banks have effectively removed the volatility by interfering with the risk-free rate. That has left many including, Blackrock’s Thiel, warning about holding traditional safe-havens, sovereign bonds.

The out-of-kilter world of negative rates enabled German household products maker Henkel to issue two-year bonds at negative rates last week.

It has left many investors on the hunt for quality to turn to emerging markets where the inflows have been described as extraordinary.

Others agree it is a risky gamble to bet against the might of central banks which still have ammunition to throw at economies.