OREANDA-NEWS. September 14, 2016. The ongoing influence exerted by central banks over the direction of global markets was reinforced by the late selloff last week. Worries that the European Central Bank (ECB) will not be adding additional stimulus to support the fragile recovery in the Eurozone and that the Federal Reserve is poised to raise rates for a second time here at home, sent bond yields soaring and stock markets plunging on Friday. On the day, the S&P 500 skidded 2.6 percent, while the EuroStoxx 50 index fell 1.9 percent. In all, the MSCI World index fell 1.6 percent. And the selloff continued in early trading this week. The Nikkei was down 1.7 percent overnight, while stocks in Europe are lower by another 2.0 percent and U.S. futures are pointing to a lower open.

Bond yields were just as sensitive to the sudden shift in sentiment. The yield on the ten-year Treasury shot up eight basis points to end the week at 1.68 percent, its highest level since late June just prior to the Brexit vote in the UK. The German ten-year note yield rose eight basis points to a yield of 0.01 percent, its first print in positive territory since mid-July. Yields are modestly higher once again in early trading this week.

Was the Recent Selloff Warranted?

The question for investors is whether this reaction is justified. If central banks were suddenly changing their tune and saying either their jobs were done, or they have already done everything they can to support the tentative global recovery and from here on it’s up to fiscal policy to carry the burden, then investors are rightly concerned. But is that what central banks are saying? It would not appear to be so, and if not, then this spasm may represent a modest opportunity. We won’t begin to know the answer until next week when the Federal Reserve meets. It has valiantly attempted to convince markets that another rate hike at this meeting is a real possibility. And all that jawboning has succeeded in sowing seeds of doubt in an otherwise skeptical audience, which now ascribes a 30 percent chance of a rate hike happening next week.

But is the Fed truly convinced that higher rates are the right policy for an economy that has just seen its manufacturing sector contract, its service sector fall to the lowest level in years and its job creation engine slow modestly? Certainly a case can be made that a hike is justified on the basis of low unemployment, the destabilizing threat of asset price distortions and the fear that inflation will eventually emerge with a vengeance. But is that case compelling enough in light of an economy that is growing at a trend rate of somewhere around 2.0 percent, where inflationary pressure is currently not much of an issue, and against a global economic environment that is even weaker than at home? Maybe by December the answer will be yes, if the data in the interim is firm enough, but not now.

What can we Expect from Central Banks Across the Globe?

What about the ECB? Did its failure to add more stimulus at its meeting last week really intend to signal to investors that it was throwing in the towel? Clearly its failure to act disappointed some, but most observers expected the ECB to wait until December to tip its hand. Its current bond buying program ends early next year and it is running out of bonds to buy under the restrictions of that program. Unless it intends to take its ball and go home, it has to do something. It has not reached its own inflation objective and growth is just okay. But, unlike the Fed, the ECB must at least attempt to form a consensus among its disparate sovereign members. That takes time and December seems like a reasonable time frame by which to agree on the shape of its forward policy.

And both central banks are dealing with uncertain political developments. The UK economy has benefitted in the short-run from its devalued currency, but the hard work of Brexit has yet to begin and its lingering economic impact remains uncertain. In the U.S., the presidential polls are tight and markets are likely to become increasingly jittery the longer that remains the case as we approach Election Day.

Then there is the Bank of Japan. It, too, meets next week, and seems likely to add more stimulus. Keep in mind that central bankers are largely the true believers in the power of monetary stimulus. It is the private sector that hates negative interest rates, not central bankers. In fact, it seems that central banks would even like to see the asset class of cash disappear altogether so that the efficacy of negative rates would be reinforced. The Fed has so far eschewed the likelihood of negative rates in the U.S., but the economy here doesn’t currently need them. That’s not the case in Europe and Japan. Sure, they would welcome some help from the fiscal authorities, but until that arrives they maintain a steadfast belief that they still have levers to pull to support their economies.

Unless the economic data firms unexpectedly, expect monetary authorities to adhere to the stimulus paths they are on. That includes the Fed next week.

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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list. 
The MSCI Emerging Markets Index captures large and mid-cap representation across 23 Emerging Markets (EM) countries. With 837 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.
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