Shift in Monetary Policy Expectations Supports Risk Assets-OFR

Office Of Financial Research (OFR), in its latest report has stated that a shift in US monetary policy expectations is supporting risky assets. Risk assets such as equities, corporate bonds, and emerging market currencies appreciated notably in October, recovering somewhat from the sharp losses in recent months. The catalyst for the rally appeared to be weaker U.S. labor market data, which delayed the expected start of monetary tightening by the Federal Reserve. Extraordinarily accommodative monetary policy has supported risk asset prices since the global financial crisis and this month's market reaction suggests that these prices may still be contingent on accommodative policy. It remains to be seen whether current U.S. asset price ranges can be sustained once the Federal Reserve begins to raise interest rates, broadly expected to occur between December and June.

U.S. equities have rebounded strongly in October, although fundamentals remain weak. The S&P 500 index has rallied since the start of October and is up 10 percent from its August low. As with the broader rally in risk assets, this rebound has been attributed to the delay in an expected Federal Reserve rate hike. The rebound has occurred in the face of weaker U.S. equity fundamentals, such as the slowdown in global growth, negative effects of a stronger U.S. dollar on earnings, and continued weakness in the energy sector. For the third quarter, analysts continue to expect negative revenues and earnings for energy stocks, with modestly positive growth for non-energy S&P 500 stocks.

 

Emerging market assets have rebounded, following months of deterioration. Emerging market currencies have rallied since the start of October, led by a 5 percent to 8 percent appreciation in commodity-sensitive currencies. Emerging market equities and credit have also advanced. Despite the rebound in emerging market assets, some of the recent gains also represent a technical recovery driven by covering of short positions and moderation of excessively bearish sentiment. Overall, emerging market economic fundamentals remain very weak. In its latest World Economic Outlook, the International Monetary Fund (IMF) downgraded its forecast for emerging market growth.

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