Equity markets witnessed a remarkable bounce over the last two weeks. In Hong Kong, the Hang Seng Index rallied 7 percent from the trough since Christmas Eve, while in the US the S&P 500 index gained 11 percent.
The big catalyst for the rebound was dovish stance of the US Federal Reserve, as the central bank suggested that it would slow or even suspend the rate hike cycle. But then, Fed Chairman Jerome Powell confused the markets again as he said the Fed’s balance sheet will be “substantially” smaller, after saying earlier that QT (Quantitative Tightening) program will be data dependent.
The overall balance sheet is now around US$4 trillion. The market originally expected the Fed to take a pause as the balance sheet shrinks to US$3.5 trillion to US$3.7 trillion. But Powell did not specify how much smaller the central bank’s portfolio should get, or how much further reduction is substantial enough.
Fed’s balance sheet has inflated to a peak of US$4.5 trillion from around US$800 billion before the 2008 financial crisis. It still printed around US$2.7 trillion even if its balance sheet drops back to US$3.5 trillion.
I support monetary tightening policy if the conditions are appropriate, in order to leave some leeway for policymakers to ease again should there be another recession.
The problem with Powell is his constantly changing rhetoric and confusing comments. Central bank should not sacrifice its most valuable asset — credibility.
Meanwhile, the US dollar has started to weaken. The dollar index eased to 95.3 points, while emerging market currencies have shown some appreciation. Chinese yuan even rallied to 6.75 against the dollar, which mitigated my concerns on emerging markets.
In my opinion, the biggest risk this year is political rather than economic. The widespread worries about slowing global growth stem partly from geopolitical risks, including US-China trade, and Brexit.
With regard to Brexit, UK Prime Minister Theresa May has been warning of the worst “no deal” scenario. If so, the pound is set to drop below 1.2 or 1.1 against the dollar. That would drag down euro as well, which would in turn push up the dollar.
But the market has not priced in the risk yet, with sterling still above 1.27 against the dollar. The market is expecting another referendum. But I think the situation is very complicated.
Over a longer time horizon, the biggest political risk might actually come from the US. In the days after President Trump fired James Comey as FBI director, law enforcement officials became so concerned by the president’s behavior that they began investigating whether he had been working on behalf of Russia against American interests, the New York Times reported last weekend.
The full article appeared in the Hong Kong Economic Journal on Jan 15
Translation by Julie Zhu
[Chinese version 中文版]
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