Liquidity rules for central bankers

James Klempster, portfolio manager, Momentum Global Investment Management believes that liquidity remains the central bankers' tipple of choice and explains his views in a recent note.

“The UK plans to raise GBP127 billion in gilt sales this year, which is a huge volume for the market to digest if there is no meaningful appetite, especially given the current lowly levels of the benchmark government bond yield and the fact that interest rates are likely to rise at some point in the relatively near future,” he says. 
He comments that safe haven government bonds remain unsustainably expensive at present levels and, as a result, investors retain low allocations to these securities, instead preferring to achieve fixed income exposure via elements of the credit markets.
“Demand at gilt auctions has fallen to its lowest level since the financial crisis - June’s auction of ten year securities marked a six year low. Perhaps take up was low because potential bidders had one eye on expected rate rises but it could also be a sign that buyers of gilts are finding it difficult to justify gilts at today’s persistently low yields. If the former, it again demonstrates the importance of central banks managing expectations as effectively as possible whilst there is an elevated level of economic uncertainty. If the latter and gilt buyers are starting to fatigue, this suggests gilt yields should rise,” he writes.
 Looking to last week’s decision from the Fed not to raise rates, Klempster says that the Fed had an unenviable task. “Had they increased rates, it is likely that the market would have responded badly on the basis that fragile economies both in the developed and developing world weren’t ‘ready’ for the US tightening its monetary policy no matter how modest a rate rise would have been.”
However, he comments, the Fed’s decision to do nothing was also greeted with negative price action globally, as market participants collectively asked ‘what does the Fed know that we don’t?’
Klempster writes: “While their inaction seemingly delays the inevitable, on balance the Fed made a sensible, if conservative choice: if action and inaction were both to be greeted badly they may as well opt for inaction over an actus reus that would have been over-analysed for decades to come.”
“Over the weekend other central bankers added their weight to the Fed’s dovish stance, with the European Central Bank’s (ECB) Benoît Cœuré suggesting the Fed’s decision to keep rates unchanged is ‘a confirmation of our diagnoses of the existence of risks in the global economy’. This sentiment was echoed by his colleague, executive board member Peter Praet, who stated ‘we share the concerns about the outlook for the global economy’.”

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