Three market moves that matter in 2015
It’s already started out as a tough year for many. On the one hand we have entered an extreme rate cutting environment, but on the other, investors remain parched for yield.
So what are we seeing from here?
1. Reserve Bank cuts will continue
We have long believed interest rates would be cut below 2.5% in Australia – it was simply a case of when and not if. Our portfolios were positioned for that rate cut.
We’re expecting at least another 50 basis points of cuts from the Reserve Bank this year, with a high probability of more.
While the Australian currency will decline further in the coming months, the fall won’t be low enough to satisfy the Reserve Bank or market participants as central banks globally race to push their currencies to the bottom to stoke domestic demand.
Over 10 central banks cut rates in January alone and this theme will continue throughout the year as the currency wars and desperate attempts to stave off deflation continue.
When will the rate cutting cycle run out of steam? Absent an increase in wage growth, we don’t think there will be any rate hikes in any major economy this year. This prediction includes the US, where wages are flatlining and falling commodities prices are placing pressure on inflation.
2. Bonds won’t behave the way you think they will
The consensus is that bond yields will rise materially throughout 2015. We disagree. We expect a rally in the first half of this year, maybe entering a bit of weakness in the second half.
Interestingly, yield curves usually steepen in rate cutting environments, signalling that an economy is on the verge of a serious upturn (or downturn) – but don’t expect that to be the case in 2015.
The game changer is that the general hunt for yield continues and by global standards, Australian bonds are incredibly attractive against their AAA rated counterparts. Continued interest in Australian assets will cause the yield curve to flatten.
3. Liquidity will be a problem
We are positive on a number of areas in the credit market, but believe there may be major liquidity issues down the track. Coming into a low growth, even lower rate environment, investors should be wary. We saw just how quickly liquidity can disappear from the market during the GFC. The recent increase in capital requirements for investment banks has serious implications for liquidity, as it reduces the market-making capabilities of the banks significantly. In times of market stress, you’ll often find there is no other side to the market.
Right now, we worry that there will be a liquidity event which starts in emerging markets and works its way through to credit markets. We are positioned defensively in light of this view.
We are in a paradigm change in how the world thinks about monetary policy and the recent events will be only a taster of what we will see over the next 10 years. We get worried about a number of asset classes and while bond yields may appear low, the wave of deflation spreading across the globe reinforces why you should own more bonds than you already do.