From BNP Paribas
Not “IF” but “WHEN central banks lose control?”
The global financial repression pushed investors to invest cash in risky assets, such as property and equity. The scale of global policy interventions is trumping all fundamental factors for now. Investors should keep in mind that the road is never straight and next month should be full of potentially disruptive events impacting sharply overcrowded assets and trades. History shows that such misallocation of resources creates bubbles that can last before fully blowing; the question is not if, but when.
Risk assets and risk parameters would be massively affected in the event central banks lose control; in the meantime, EDS Asia believes that central bank maturities that use forward guidance matter more than the QE process itself. The Fed and the ECB have been providing guidance which partly explains the low short-term volatility. The BoJ is moving toward this behaviour, managing the news flow: therefore there is a case for the NKY index going up slowly with a lower upfront volatility and a term structure closer to the US one: in that sense, we have started to observe an “SPX-isation of the NKY Index” in the past few months before this summer’s risk-off, as short dated volatility was trading lower. In China, the PBoC intervention learning curve is steep; this is the reason we believe the next equity leg up will be accompanied by an elevated volatility regime.
The quantitative easing started in the US more than six years ago and the SPX index, as well as selective risky assets, are now hovering at the high end of their valuation histories. Recent price actions are testimony of the fragility of imbalances built over the years. Investors may recall the Japan easing experience in 2005 and 2006; an early exit, together with a global financial crisis, caused a Japanese equities meltdown (between mid-2007 and late-2008).
In the decision tree, EDS Asia addresses the potential “QE end-game scenarios” [attempting to] answer the question “Are central banks losing control?” and providing a time horizon and probabilities affecting each path, which should allow investors to get a clearer overview.
