Q1 2016 FFTW Quarterly Commentary: The more things change, the more they stay the same

07 Apr 2016


In this paper, we take a look at following topics:

  • Are the downside risks to global growth even more pronounced than they were a few months ago?
  • Do we anticipate continued policy easing by several emerging and developed market central banks?
  • Will the Federal Open Market Committee (FOMC) look past any firming of inflation in the US?
  • What major themes do we expect to see in the second quarter and for the remainder of 2016?


There is a saying in French, “Plus ça change, plus c’est la même chose”, which translates loosely as, “The more things change, the more they stay the same”. This phrase neatly sums up the events of the first quarter, which saw a sharp sell-off and subsequent rebound in risk assets. Concerns over the most adverse outcomes for global growth and markets have greatly diminished in recent weeks, as some of the more destabilizing narratives that drove risk-off sentiment during the first six weeks of the new year have faded for the time being. These narratives were varied but many shared a common concern about whether economic policies in key economies would ultimately be ineffective, and potentially harmful to the global economy. One of the main narratives weighing on risk sentiment early in the quarter was the perception that Chinese policy-makers would engage in a meaningful and possibly destabilizing currency devaluation, either to support growth and inflation or simply as a result of an inability to re-anchor exchange rate expectations and stem capital outflows. This concern began to take hold last year, but gained momentum when Chinese authorities started 2016 with a series of weaker reference fixings for the value of the yuan against the dollar.

The concern over China’s exchange rate policy also provided fuel for a second, long-simmering narrative, that central bank actions since the Global Financial Crisis amounted to little more than “beggar-thy-neighbor” policies that work primarily through currency depreciation. Of course, developments in China were certainly not the only factor contributing to the re-emergence of this narrative. Expectations for additional stimulus by the European Central Bank (ECB) and Bank of Japan (BoJ) also fed into this concern over currency wars. And as currency wars are viewed as ineffectual over the longer term, a third narrative took hold early in the new year, that central banks were essentially running out of ammunition to boost growth and inflation. This narrative reflected a growing view that quantitative easing (QE) faces diminishing returns over time, and that bond purchases could run into capacity constraints as central banks delve further into the available supply of sovereign bonds. Similarly, taking overnight policy rates deeply into negative territory could undermine recoveries by hurting bank profitability. The BoJ’s decision to cut its deposit rate below zero in early February only fed into these concerns, as it was viewed as both an indication that asset purchases in Japan were no longer a viable policy, and that other central banks were also increasingly likely to rely on negative interest rates. And if many central banks were seen as running out of policy tools to provide stimulus, the Federal Reserve (Fed) was increasingly perceived as willing to risk a recession by continuing to raise rates after its first move in December 2015. Lastly, central banks were not the only sources of the narratives that drove negative risk sentiment. Crude oil prices continued to decline early in January, which amplified concerns about the global growth outlook as well as the health of companies and countries reliant on oil-related revenues. The confluence of these negative narratives resulted in a massive sell-off in risk assets and a rally in G4 government yields, the magnitude of which had not been experienced since the so called “Taper Tantrum” of August 2013.

Almost as quickly as it fell, markets experienced a subsequent improvement in risk sentiment. In addition to somewhat irresistible spread levels, the improvement in sentiment was due, in no small measure, to the recovery in crude oil prices beginning in mid-February and central bank communications that helped to stabilize markets. The People’s Bank of China (PBOC) not only refrained from further devaluations, but on net has set the reference rate for renminbi somewhat stronger over recent weeks. In addition, comments by PBOC Governor Zhou increased investor confidence that China’s foreign exchange policy would not be a source of market instability. Elsewhere, the ECB’s creative use of new credit easing measures served as one illustration of how central banks retain sufficient policy flexibility even at negative interest rates, and can structure policies to mitigate adverse effects on bank profitability. Finally, the Federal Reserve has not only communicated a greater willingness to tolerate inflation overshoots, but signaled at its March meeting an even more gradual path of interest rate increases in the face of global risks to the US economy.

These events greatly reduced perception of tail risks and led to a marked turnaround in the performance of risk assets. For example the MSCI world stock index, having been down close to 12 percent for the year through February, staged an impressive comeback and ended the quarter close to flat. High yield and investment grade bonds staged a similar turnaround. These developments led to a considerable easing of financial conditions, particularly for the United States, as expectations for a more gradual path of policy rate increases, combined with an apparent tilt by other central banks away from over-reliance on currency depreciation as a policy lever, has led the trade-weighted dollar to depreciate to its weakest level since October.

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