- The gradual exit of major central banks from bond markets is straining global liquidity, according to Rick Rieder, the chief investment officer of global fixed income at BlackRock.
- Emerging-market assets are already showing signs of stress and there may be more volatility ahead.
- The US economy is still on a firm footing but risks an economic slowdown from the second quarter’s pace, Rieder said.
Rick Rieder is worried about liquidity.
According to the chief investment officer of global fixed income at BlackRock, the retreat of central banks from credit markets could worsen liquidity, or complicate how smoothly other investors are able to do the same.
Rieder, who oversees $1.9 trillion in assets, has been voicing this concern for several months as central banks reduced their bond purchases.
Back in January, the Bank of Japan said its balance sheet shrank month-on-month for the first time since it started buying government bonds, equity exchange-traded funds, and other assets in late-2012. In June, the European Central Bank said it was set to end the €2.5 trillion ($3 trillion) bond-buying program known as quantitative easing that it initiated after the eurozone debt crisis. The Fed continues to slowly unwind its $4 trillion-plus portfolio of bonds.
As central banks work quietly and slowly, more powerful forces are brewing in the foreground, Rieder said in a recent note.
Of the US economy, he said: “We think that at some point over the next year, or so, eventual higher wages, and other higher input costs for companies (particularly if accompanied by sustained tariffs), as well as a pull-forward of capital expenditures by companies, may lead to an economic slowdown from the second quarter’s buoyant pace.”
He continued: “We’ve also been quite vocal regarding our concern over the deceleration in the pace of growth of global liquidity and think that financial markets are already displaying ample “canaries in the coal mine” that suggest we may be in store for higher volatility, or financial market shocks, which hold the potential to diminish business or consumer confidence.”
Some of these canaries, or warning signs, can be found in emerging markets.
On a total-return basis, the MSCI EM index is down 11% this year and is the worst performer besides gold on a Bank of America Merrill Lynch ranking of major assets.
Rieder flagged the potential for a stronger dollar as a potential setback for liquidity and calm in emerging markets, because it’s the world’s reserve currency and the primary way debt is funded.
The dollar’s rise this year, following its worst since 2003, is already weighing on emerging-market assets, according to Erin Browne, the head of asset allocation at UBS Asset Management.
“What’s interesting about that is if you look at the correlation of EM equities relative to the US dollar, it’s very highly correlated, which is telling you that the move that we see in EM assets right now is largely being driven by the dollar,” Browne said at a media roundtable on Friday.
EM equities fell 17.7% from their peak in early February to late-June, worse than the 14% drop during the taper tantrum of 2013, Browne said.
Meanwhile, the US economy remains on a firm footing. At least, that’s the opinion of Federal Reserve Chairman Jerome Powell, who faced lawmakers in Congress last week.
The Fed is forging ahead with gradually raising its benchmark rate as long as economic conditions allow. With the unemployment rate near the lowest since 2000 and inflation under control, the Fed has much of the clearance it needs.
“The main question becomes: what is the next phase for the economy,” Rieder said after Powell’s testimony.
Also, investors are grappling with the implications of the shrinking spread between the 2- and 10-year note yields, which Morgan Stanley has forecast will go negative — implying a yield-curve inversion — by 2019. An inverted yield curve has preceded every recession since the 1960s, though with a time lag of nearly two years on average, according to LPL Financial.