Tags: uncertainty | volatility | financial markets | investors | central banks

Central Banks' Uncertainty to Fuel Investor Risks in 2018

Central Banks' Uncertainty to Fuel Investor Risks in 2018
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Tuesday, 02 January 2018 08:55 AM Current | Bio | Archive

There is probably no more irrelevant way to start the new year than with a selection of purchasing manager indicator (PMI) business sentiment opinion polls.

Attention paid to these indicators seems to have risen as their relationship to the real economic world has fallen.

Overnight, a few manufacturing opinion polls in Asia have weakened.

What does this tell investors about the state of the global economy?

Absolutely nothing.

  • They could have changed because the economy has changed.
  • They could have changed because the tone of media commentary has changed.
  • They could have changed in an attempt to influence policy.
  • They could have changed because they are filled in by people who guess at the answers.
  • More of this data from the Euro area was released this morning that shows that the Eurozone Manufacturing PMI ended 2017 at series-record high.
  • The IHS Markit U.S. and Global Manufacturing PMI will be released later in the day.

Tensions in the Middle East are unlikely to be too much of a concern for financial markets’ investors.

The protests in Iran are in my opinion essentially a local affair, and for now they seems to be looking for a reason to suppose that there won’t be any contagion elsewhere.

Investors will not price in extreme risks in this sort of situation because investors never do price in extreme risks in this sort of situation.

Oil supply does not seem to be impacted at the moment. Oil pipe-lines are generally away from urban centers of population.

So, what lies ahead for 2018?

We should remember that financial markets and the real world of economics are not necessarily the same thing.

The issues around central bank tightening are probably one of the clearest illustrations of the difference.

This year, for the first time in decades, the Fed will have a smaller balance sheet at the end of the year than it did a the start.

Central bank tightening this time differs from the tightening of the 1980s and the 1990s.

  • Central banks are not seeking to lower inflation.
  • Central banks are not trying to attack company pricing power.
  • Central banks are not attempting to lower demand to reduce “overheating.”
  • Instead, central banks are tightening to maintain a balance.

For the real economy, as long as central banks are competent enough to maintain that balance between liquidity supply and liquidity demand, there is nothing to change the economic path this year, which is of trend-like growth and maybe somewhat inflation that is a little higher as the year progresses.

Indeed, most central banks have been organically tightening quantitative policy for some time now by allowing liquidity supply to grow more slowly than liquidity demand, which is a slow but certain way of reducing surplus liquidity in the economy.

However, the effects of tightening economic liquidity in the financial markets are less clear.

Central banks will buy fewer bonds than in the past. Liquidity to financial markets may, or may not, be affected by central bank tightening depending on what happens to liquidity demand in the economy.

Risk appetite often increases as liquidity preference declines, but this is not an easily predictable relationship.

All of this adds an element of uncertainty to the financial markets’ outlook, raising the possibility of volatility.  

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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All of this adds an element of uncertainty to the financial markets’ outlook, raising the possibility of volatility.  
uncertainty, volatility, financial markets, investors, central banks
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2018-55-02
Tuesday, 02 January 2018 08:55 AM
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