Markets are likely to remain volatile and investors risk averse as the US Federal Reserve’s (Fed) determination on possibly tapering quantitative easing (QE) and "complacency" on low inflation could lead to a policy mistake, said Gary Dugan, chief investment officer, Asia and Middle East at Coutts.
Dugan said, in the recent Coutts Wealth Watch, that the US Federal Open Market Committee (FOMC) statement and subsequent press conference led by Fed Chairman Ben Bernanke have added "considerable near-term volatility" into the markets.
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The key message being put out there is the Fed’s apparent determination to taper QE before the end of 2013, possibly starting September onwards. Bernanke has also suggested that QE may end entirely in mid-2014 if the US economy is on a sustainable growth path. The Fed has increased its GDP forecasts for 2013 to 3-3.5% from 2.9% to 3.4% as well.
Coutts, however, suspects that the FOMC has made a "policy mistake".
"We do not believe that growth is as robust as the way the Fed has characterised it. The tough call is knowing when the Fed might shift its view again," said Dugan.
According to Dugan, the Fed still expects the inflation to be at or just below its 2% target, which is a "key surprise".
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By GlobalData"Bernanke talked about a number of one offs that are keeping inflation low at the moment and that they expected to reverse. However if you look around the world at the moment there are many signs of falling inflation."
Influence on assets
Dugan said in the light of the Fed’s views, Coutts expects developed markets to outperform emerging markets when it comes to equities, and the private bank’s preference is for Japanese equities in particular.
"In the near term, investors are going to worry that higher US rates will encourage further flows of capital out of the emerging markets. Also those investors who believe the Fed is making a policy mistake will worry that emerging market growth will be hurt by any slowdown in the US," explained Dugan.
Dugan also advises a cautious approach towards the US dollar. "Our broadly pro-dollar view has reflected our assessment that the US economy is likely to see further recovery over the medium-term, but we are not as confident as the Fed appears to be.
"More importantly, we see a big risk that the market will not be as confident as the Fed for some time. Until market expectations for growth are aligned with those of the Fed we may be in for a rough ride," said Dugan.
QE tapering threats
According to Duncan Lawrie Private Bank, the increase of liquidity into global markets has created dangerous market valuations that will pose serious risks to investors when the QE is finally tapered.
With the US’ plans to cut back its QE programme and UK figures indicating a stronger economy with less QE stimulus, investors in search of high yield returns may see their investment plummet, as liquidity in some markets dries up and the high yield bubble bursts, reported Duncan Lawrie Private Bank.
