Dovish for how long?

While the Fed (and Emerging Markets) may be enjoying a boost from weakness in the dollar, we would question how sustainable the current dovish stance of the Fed is

It is important to stress that, in a world of small numbers, changes are important at the margin but, in our view, it is unlikely that markets will price in convergence of US policy with that of other major central banks. In other words, the US will, ultimately (and dependant on market response in the meantime) move to tighten policy further, which will potentially mean that the recent dollar weakness proves temporary. Japan cannot tolerate significant further strength in the yen and, with investor confidence in Abenomics evaporating and inflation expectations falling, pressure is growing for a response. As deflation builds then authorities there will seek new ways to stimulate growth. Of the three arrows of a) monetary stimulus, b) fiscal stimulus and, c) structural reform, a rethink is required. We have seen, in the past eight years, how unconventional views have become conventional over time and how fringe ideas on monetary policy have become embraced (and implemented) by the mainstream. The next phase of experimentation will likely begin in coming quarters. Fiscal expansion through monetary financing is no silver bullet but remains an option for Japanese, and global, policy makers. Already the fringe ideas are becoming debated more seriously and it is likely that more desperate policy makers will resort to the adoption of new, bolder means of impressing the markets and stimulating growth and inflation expectations.

Investors are considering whether the tide has turned for the dollar, commodities and EM assets as well as whether the game is up for central bankers, in Japan and Europe specifically. Unpredictability of policy cross-currents makes shorter-term markets difficult to navigate but it remains important to focus on fundamentals as well as continuing to be open minded on the next phase for the global economy, and policy, post the Global Financial Crisis. The global economy remains fragile and far from normal, and so risks abound.
From our perspective, structurally, the deterioration in productivity remains a concern and stagnant underlying corporate earnings growth alongside an apparent peaking in US corporate profitability is concerning and represents a headwind for global equities. This, combined with valuations, which are reasonable, but not particularly attractive, leads us to maintain some longer-term caution on the outlook for US equity market returns.

Team Multi-Asset – BMO Global Asset Management