Fed Tightening To Trigger Market Tremors As Liquidity Evaporates
Complacent investors will be hurt as Fed raises rates, says BlackRock, as managing director warns central banks are running out of ammunition to deal with next crisis
The smooth ride investors have enjoyed in a world of ultra-loose monetary policy is coming to an end, according to BlackRock, which warned that complacent investors could be left floundering in a world of evaporating liquidity when the US Federal Reserve begins to raise interest rates.
Russ Koesterich, chief investment strategist and managing director at the world's biggest asset manager, said that while the "very gentle" tightening expected by the Fed was unlikely to rock markets in the same way as the "taper tantrum" did in 2013, a "flash crash" in benchmark US Treasury yields last October served as a warning that some investors could be left high and dry when the US central bank raises rates – perhaps as soon as this summer.
Central banks are pulling out everything in their arsenal ... You have to be a little bit concerned that if there's a shock to the global economy, does that push developed countries further towards deflation? It's not unrealistic."
"The Fed hasn't raised rates for nine years," he said. "That means you've got almost half a generation of investors who've never lived through a tightening cycle.
"It's going to cause some angst among individual investors, and if you do see some liquidations, that's going to be one instance where we might be testing liquidity, how investors react and the market's ability to absorb that reaction.
"Investors who became very accustomed to this nice simple ride that we've all enjoyed do need to get prepared for a rougher ride… normal is going to feel difficult following this period of very easy markets."
Mr Koesterich also warned that the world was running out of ammunition to deal with the next crisis, saying that one more shock could plunge advanced economies into deflation.
"Central banks are pulling out everything in their arsenal. We've had quantitative easing in the US, QE in Europe, QE in Japan. Emerging market central banks are lowering rates – and that's in a very low- inflation environment.
"So there are secular factors, changes in demographics and technology changes that are keeping inflation low. You have to be a little bit concerned that if there's a shock to the global economy, does that push developed countries further towards deflation? That's one reason why bond yields are where they are. It's not unrealistic."
Ray Dalio, the founder of hedge fund Bridgewater Associates, has warned that the Fed risks "knocking over the apple cart" and triggering a 1937-style stock market crisis when it starts to raise rates.
In his annual letter to shareholders, Jamie Dimon, the chief executive of JP Morgan, said discord in the US Treasury and currency markets were a "warning shot across the bow", anticipating the turbulence during the next crash.
While Mr Koesterich said the very slow pace of tightening expected from the Fed meant the blunders of 1937 were unlikely to be repeated, he said investors would not "know the full extent of [any liquidity storm] until the market is tested".
Mark Carney, Governor of the Bank of England and head of the Basel-based Financial Stability Board, has also warned that diverging monetary policies were likely to "test capital flows across the global economy, including emerging markets".
Investors who became very accustomed to this nice simple ride that we've all enjoyed do need to get prepared for a rougher ride? normal is going to feel difficult following this period of very easy markets.
Mr Dimon warned that tougher bank regulation meant the next financial crisis would trigger more market volatility, as capital rules made it too costly for banks hold large stocks of securities to trade. Mr Koesterich agreed.
"Liquidity has changed and not for the better. Part of this is a by-product of changes to bank regulation in the post-crisis environment, and it's understood that there are corners of the market, particularly in corners of the bond market where you have to realise liquidity is not going to be what it was pre-crisis."
The Bank of England warned last month that a global liquidity storm could endanger financial stability if investors suddenly demanded their money back.