The Federal Reserve (Fed) surprised and confused markets at its September policy meeting by emphasizing that it is “monitoring developments abroad.” In her press conference following the Fed decision, Chair Yellen mentioned either “China” or “global” 16 times. The Fed has a dual mandate of promoting full employment and targeting 2 percent inflation (also the objective of moderate long-term interest rates). However, the sharp focus on global developments in its statement and subsequent press conference led some to talk about a “third mandate” in addition to its domestic focus.
The Fed had spent much of the year preparing markets for an eventual increase in interest rates, so the decision to hold off in September caught some by surprise (and perhaps predictably led to conspiracy theories along the lines of “what does the Fed know about China that we don’t know?”). We are doubtful that the Fed has any special insight into Chinese economic developments, particularly given the opacity of Chinese data. However, the mention of global developments is significant and signals that the Fed will take such factors into account going forward.
There have been multiple instances of central banks wrong-footing investors over the last year. Most glaring was the Swiss National Bank’s decision to abandon its three-year policy of capping the Swiss franc against the euro, after reaffirming its commitment to the policy just days before. The franc appreciated as much as 41% on January 15, 2015, the day the change was announced. This was one of the largest currency moves since the collapse of the Bretton Woods system in 1971.
The Bank of Japan appeared to deliberately surprise investors with the expansion of its asset purchase program last fall. Multiple times in the preceding month, Bank of Japan Governor Kuroda had expressed confidence in reaching their 2% inflation target. Additionally, the Bank of England has flip-flopped with respect to the timing of potential rate hikes, leading one lawmaker to call Bank of England Governor Mark Carney an “unreliable boyfriend.”
These actions may lead one to wonder if central banks may be deliberately attempting to surprise investors in an attempt to get the most “bang for the buck” with respect to changes in policy. Much of the last 20 years of central bank policy was spent on attempting to improve the transparency of actions and communications (former Fed Chairman Bernanke has conducted a great deal of research on exactly this point). However, due to greater uncertainty regarding the economic recovery from the global financial crisis, it is possible that central banks are looking to move away from policy transparency. This may result in greater financial market volatility and reduced confidence in central bank policy. In fact, a recent survey of 135 clients by RBS showed that 63% think that monetary policy is losing credibility in financial markets. Regardless, it appears that global central banks will continue to attempt to backstop financial markets in response to any potential slowdown in economic growth.
Central bank policy has been a main driver of our overweight equity stance, as well as our overweight to international developed equity. A Fed which is in no hurry to raise rates should be supportive of risk assets. Additionally, it is looking more likely that the European Central Bank and the Bank of Japan will expand or extend their asset purchase plans, which we believe would provide further support for European and Japanese equities.