Great expectations: Why central bank forecasts are crucial for stock investors
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2020 stock markets were defined by historic levels of stimulus support. And in 2021, investors are on the lookout for what happens if (and how) it’s rolled back.
It’s become the most topical theme on markets over the past month, as bond markets began to ask the question — how long can interest rates remain at rock bottom?
And it’s in focus this week as most of the world’s largest central banks are scheduled to provide an update on their policy settings.
Taper tantrum squared?
"Valuations are currently extremely demanding, which make stocks vulnerable to a change in rates. This is unlike the 2013 taper tantrum period when DM equities were largely unscathed because the valuation risk was muted," @bcaresearch says. pic.twitter.com/kREvVxfoPN
— David Scutt (@Scutty) March 15, 2021
For central bank policy makers at the RBA and the US Fed, it’s all about managing expectations.
Right now, the expectation is that policy makers will let the economy run hot and worry about the next steps later.
“Let inflation become a problem before it is a problem, and then figure it out down the road,” as investor James Whelan told Stockhead last week.
(Post-COVID) monetary policy is a complex beast though, and it’s not just interest rates that investors need to be aware of.
A good example of that is the details in the minutes from the RBA’s March meeting, which came out yesterday.
Prior to the release, CBA economist Belinda Allen was focused in particular on what the RBA would say about its Yield Curve Control (YCC) program.
(Announced at the height of the March 2020 panic, the YCC keeps the yield on three-year government debt capped at 0.1 per cent).
Allen thought the RBA might announce plans to remove it, now there are lots of signs the economy is improving.
Instead, the minutes showed it “would not consider removing the target completely, or changing the target yield of 10 basis points”.
So YCC is here to stay. And the only policy wrinkle is whether the RBA continues to target bonds with a maturity date of April 2024, or extends YCC to bonds maturing in November that year.
In commenting on today’s minutes, Allen said the RBA is maintaining the “powerful nature of dual forward guidance”.
Holding interest rates at 0.1 per cent is one thing. But by maintaining YCC the central bank is effectively “anchoring all shorter rates” three years and below, she added (lock in a fixed loan while you can).
So breaking down the detail, the RBA minutes doubled down on what the bank’s expectations are — flat rates for three years.
That provides a guide for stock investors to base their decisions on, because the link between rates and stock prices is a relevant one.
Is inflation coming? The RBA doesn’t think so. CPI growth is expected to jump in the June quarter off a low base, but the bank is already prepared for that.
For inflation growth to prove more than just transitory, yesterday’s minutes showed the bank reckons Aussie wage growth will have to rise sustainably above three per cent — a level it hasn’t hit since the mining boom in 2013.
Next up is the US Federal Reserve, which will make its policy announcement on Wednesday night.
The Fed’s expectations are similar to the RBA — let things run hot for a while.
There won’t be any changes to that view, but by the time Aussie traders get to the desk on Thursday morning, global analysts will have run the ruler over every last detail of the Fed’s announcement.
Small details could change the market’s view around when the Fed might taper its asset purchase program, for example.
This week, it’s all about the dot plot. If it projects “a higher Fed Funds rate in 2023 than (the one) in December”, Allen said, then markets will know about it.
And as the chart above above shows, even a small shift in expectations could flow through to an outsized impact on equity markets.