Mark Fowler: Bond and currency markets not the signal they once were?


In the past, there was a near universal consensus that bond and currency markets are much better at reading the macro-economic picture impacting financial markets, and thus can be a useful guide for equity investors when assessing risks and the direction of share markets.

Currently, if we were to look at equity markets you wouldn’t guess that many industries will be either permanently impaired or face prolonged recoveries or that political and social risks are rapidly rising.

High yielding debt instruments (riskier bonds) are now back to some of their lowest levels in yield, and currency markets have been stable with little in the way of price volatility.

Does it mean, therefore, that there are no risks on the horizon, and neither Covid nor the US elections, China nor Brexit are likely to disturb markets?

The answer I would have thought has to be no. Risks are ever present but divergences between markets and reality are common, and in fact, markets have known to be wrong from time to time.

However, today, this must be adjusted for by the role that governments now play in modern asset-based economies.

In the past, divergences were due to market psychology and incomplete information; but now there are other factors.

First, we are now highly indebted, with global debt exceeding around three times and financial assets five times GDP. This implies that capital markets are now the dog and real economies are merely the tail, and what happens in that “cloud of finance” determines the reality. It is government intervention on steroids.

Secondly, bond and currency markets are no longer “signals”, but interpreters of government responses, and their current signalling is that neither defaults, price discovery nor volatility can be permitted while an inflationary surge is unlikely.

In the initial aftermath of Covid, many market commentators were predicting residential house prices in New Zealand to be down somewhere in the region of 10-15 per cent.

The market then witnessed the large-scale government response and now we are hearing reports that this same market could move higher in 2021 by as much as 10 per cent.

It is now governments and central banks that stand between the chaos of falling asset prices, job losses and consumption.

Bond and currency markets are no longer the signals they once were. In an environment of non-existing signals, sticking with portfolios makes sense.

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