Volatility Returns

28th June 2013

The world’s stock markets turned jittery towards the end of May.

As the graph of the FTSE 100 below shows, the UK stock market enjoyed a good start to the year until the second half of May, at which point it started a swift reversal. There was a similar pattern in the USA, Europe and Japan (which at one stage was up 55% from its January 1 reading).

Ben, bringer of bad news

The drop in the markets has widely been attributed to the comments made by Ben Bernanke, chairman of the US Federal Reserve (the Fed). On 22 May, in a testimony to Congress, he suggested that the next few months could see the beginning of a ‘tapering’ of quantitative easing (QE).

A translation, please…

For some while now the Fed has been electronically creating about $85bn of cash each month and using it to buy government and mortgage bonds in an effort to stimulate the US economy. Many commentators believe that this flow from the Fed’s printing press has not so much boosted the Uncle Sam’s economy as fuelled the rally in global investment markets, from US shares to emerging market bonds. After all, that $85bn a month has to find a home somewhere.

The sellers came out in force after 21 May because they feared that without Ben’s beneficence, markets would fall.

Now what?

In June Mr Bernanke spoke further about the future of QE, suggesting again that the next few months could see the flow beginning to ease and that by next summer the tap could be turned off completely. However, he did add two important caveats, which seem to have been overlooked by jittery markets:

  • The tapering is subject to satisfactory progress for the US economy, measured both in terms of the unemployment rate falling to around 7% (it is currently 7.6%) and inflation remaining within target range (at 1.1% it is undershooting at present). If either measure disappoints, then the pace of QE tapering would be reviewed.
  • An end to QE is not the same as an end to ultra-low short-term rates. The Fed has restated that it sees short-term rates remaining unaltered until the unemployment rate hits 6.5%, which could well mean no change until 2015.

QE was never going to last for eternity and the Fed’s plans show its ending will be driven by the strength of the US economic recovery. So far, the markets are concentrating more on the loss of that $85bn a month than the benefits of a stronger US economy.

In those immortal words, the best advice is ‘don’t panic’.   If you want to talk to us about your investment portfolio please get in touch.