Judging
by the evolution of financial markets, the investor mood has been upbeat during
the summer months. Last year’s turmoil related to the surprise devaluation of
the yuan is a distant memory, and European equity indices have recovered rather
quickly since the Brexit referendum. As another manifestation of a ‘risk on’
environment, corporate and emerging markets bonds have declined significantly
in recent months. Although it’s not the only reason, central banks have again
played a key role.
The Bank of England has reacted forcefully to the prospect
of a worsening of the real economy and investors still expect more action from
the ECB and the Bank of Japan, even though the latter’s most recent meeting
outcome had disappointed markets.
Most importantly, the more hawkish tone from
several Fed officials did not weigh on sentiment, perhaps because investors
focus more on the Fed’s emphasis on the low neutral rate interest. This is the
rate which neither stimulates nor slows down the economy. A low neutral rate,
which is the Fed’s view, implies that the cumulative tightening in this cycle
should be limited and hence should not cause any disruption to speak of in the
real economy.
This would imply that the prospect of a Fed tightening later this
year becomes less of an issue. The other less benign interpretation is that
investors are simply too complacent about the likelihood of a rate hike,
despite the strong US employment numbers as of late.
