Central banks are changing their tune
Kuala Lumpur


The 2008 global financial crisis saw major central banks respond by easing monetary policy in unconventional ways such as asset purchases and even negative policy rates.

These actions were done to stimulate growth by easing financial conditions and lowering the costs of borrowing for businesses and consumers.

After all the years of stimulus, global growth has finally returned and is synchronised, as conditions improved across both the developed and emerging world. Major institutions like the International Monetary Fund (IMF) have been revising their estimates for global gross domestic product (GDP) in response.

In the US alone, corporations are increasingly confident of prospects as inferred from various sentiment surveys.

The CEO Index and the US Philadelphia Federal Reserve’s (Fed) Future capital expenditures survey indicate American businesses are planning to invest more moving forward.

Leading indicators, whether it’s the developed economies or emerging markets, point to continued expansion as well.

The readings of the Global Purchasing Managers’ Index for the composite, manufacturing and non-manufacturing segments have gradually been on an uptrend since 2016.

These leading indicators together suggest inflationary pressures are building, particularly with the synchronised pick-up in growth momentum at this juncture.

On the monetary front, we expect policymakers to continue normalising monetary policy as growth and inflation pick up.

Various members of the Federal Open Market Committee have mentioned “strong labour market” and “removal of accommodation” in recent official speeches and conferences.

The frequencies have steadily risen since 2014. In Europe, the appearance of the words “inflation” and “recovery” have crept up since 2015, a healthy sign of growth being increasingly entrenched in the Euro-region, as the bogeyman of deflation has haunted the minds of policymakers there since the sovereign debt crisis.

Central bankers are clearly acknowledging improving growth dynamics and have communicated publicly their intentions to gradually normalise their respective monetary policies, via balance sheet reduction and higher policy rates.

As the major central banks slowly unwind their stimulus programmes, the buying pressure on assets they have been purchasing will gradually decrease, and this will lead to a higher volatility regime com- pared to what we have seen over the past seven years (persistently low volatility).

More volatility could be expected not just in equity markets, but also in fixed income and currency markets, particularly if the paces of normalisation by the various major central banks are not simultaneous and differ in duration and pace. For investors who are particularly concerned over currency volatility, they may find the ringgit-hedged asset classes relevant, particularly for the fixed-income portion of their portfolios.

The hedge will help to mitigate adverse effects from currency fluctuations vis-à-vis the ringgit when volatility picks up on the foreign-exchange front.

Apart from central banks slowly stepping away from purchasing assets, policy rates are expected to be gradually hiked.

The Fed has led the way in this, but other central banks like the European Central Bank are expected to eventually normalise interest rates going forward.

For the bond markets, we recommend investors lower their duration exposure as the higher an asset’s duration the more sensitive it is to changes in interest rates. We believe the short duration space is the best bet for capital preservation until valuations are more attractive across bond markets.

Investors would also want to consider lowering their exposure to the riskier segments of bond markets given high valuations.

Against a backdrop where risk-free rates are climbing amid tightening by central banks, we foresee bond yields to follow suit as yield spreads are already at compressed levels.