New article from Tatton Investment Management: QT to reverse QE and 2-year transition period to soft

22 September 2017

There had been substantial anxiety in capital markets community about the day the US central bank would announce the reversal of its monetary policy of quantitative easing (QE) towards quantitative tightening (QT). Well, the day came and went, and it has still been a good week for investors. Stock markets remained positive and bond markets remained calm.

Earlier in the week, the proliferation of threatening language between US president Donald and ‘Rocket Man’ Kim had been ignored by markets. Likewise, Theresa May’s Brexit speech to the EU in Florence on Friday was highly anticipated, but despite disappointing on the side of detail markets took it in their stride.

It almost seems as if all the big worry points of the past have suddenly lost their relevance and all capital market forces care about is consistency of central bank messaging and action, current macro-economic data and the next round of corporate earnings results.

True, economic data paints an encouraging picture, especially across the Eurozone and even the UK had some strong retail sales numbers to report for August, despite inflation climbing even further. But entering uncharted monetary policy territory as the US Fed for the first time in history unwinds QE by cancelling money it created (‘printed’) some years ago, or hearing how two nuclear armed nations threaten each other with total destruction may also point to the proverbial ‘quiet before the storm’.

As our regular readers know, we stick to the facts first and foremost, but will take market sensitivities into account, as they determine how quickly directional changes can occur.

At the moment both feel relatively reassuring. The major global economic areas continue to expand – some more dynamically, some less - but still in unison. Bond yields have recently recovered again as the demand for government bonds over war fears reduced.

Beyond the North Korea issue, political risk is reducing as well. We reported last week that there is now a ‘risk’ president Trump will actually make some policy progress around his tax reduction and infrastructure improvement plans. Germany will vote on Sunday, not whether Angela Merkel will be their head of government for the next 4 years, but merely in coalition with whom. The interesting insight will only be how many votes the populists on the right and left will gain. And finally Theresa May’s indication that an extension of quasi EU membership for at least 2 more years after the formal Brexit in 2019 will be necessary as a necessary transition period, only confirmed what most market strategists had seen as an inevitability anyway.

All in all not a bad position for the usually less benign month of September. Whether the constructive environment can last, depends on a number of factors that are very hard to predict. Will the US, China and Russia find a way out of the North Korea conflict that minimises collateral damage? How will China’s president Xi steer the second largest economy once the 19th party congress makes him as powerful as Mao? And most importantly from an investment point of view, how will bond investors react, once they realise that the US economy continues to thrive despite the Fed’s QE reversal - which would leave them holding assets whose yield may not even compensate them for more normal rates of inflation for years to come.

In conclusion, it would be unwise to be complacent, but there is also no reason for particular precautionary measures as there may have been at the beginning of the year. On this basis, Tatton’s investment committee has decided to close the US$ underweight position across our investment portfolios by increasing our US equity position back towards a benchmark neutral position. While we continue see more equity upside from our overweight position in European stocks, we believe the US$ weakness is highly likely to turn to at least temporary $-strength before the end of the year.

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