GO
Loading...

Markets also give forward guidance

Professor Moorad Choudhry, Department of Mathematical Sciences, Brunel University
Tuesday, 10 Sep 2013 | 1:16 AM ET
The Bank of England
Getty Images
The Bank of England

Market signaling behavior has taken on a distinctly odd hue of late. To say that stock prices and government bond curves have been sending out mixed messages all year would be an understatement.

This should not surprise us. In the five years since the bank crash, the assumption of bank risk by sovereign authorities (via nationalization) and hefty monetary policy support from central banks has meant that the private sector is now mixed in with the public sector. As we've noted in this column before, the result is that for equity investors there is a feeling that they can't lose – if prices go up, great. And if prices go down, just wait for the central bank to step in and they will go up again. Brilliant!

But other markets are less sanguine, and remember that unemployment is high, trade flows are down and recession is still in the air. Hence the mixed messages. But surely any indication that central banks may start slowing down asset purchases, or (heaven forbid) raise interest rates, should be taken to be good news, because it means the economy can begin to stand on its own two feet?

(Read more: Carney unveils Fed-style forward guidance)

I assume that only those of us who think the economy – any economy – is still not yet in growth mode would still wish for central bank support to continue as it has been. So why not trust the output statistics?

Consider this statement from the consistently excellent "Buttonwood" column in this week's The Economist: "But weak commodity prices are leading to lower headline inflation rates, giving central banks in the rich world plenty of scope to continue with their supportive monetary policies."

Which one is it, inflation or GDP levels and jobs? We should be looking everywhere for signs that central banks can start withdrawing their supportive policies, not continue them. Otherwise all we do is continue building the house of cards that is the Western stock market.

(Read more: BoE split on forward guidance; unemployment steady)

And so to our headline. In the UK, gilt 10-year yields touched 3 percent for the first time since the crash and are now double what they were a year ago. But didn't Bank of England Governor Mark Carney signal that base rates weren't going to rise until (among other things) unemployment levels hit 7 percent?

We'd previously questioned the logic of connecting short-term interest rates with a metric such as unemployment, which is influenced by myriad causal factors. But another reason one might wish to leave off the "forward guidance" is that the market will still take its cue from more orthodox indicators, and the robust picture emerging for the U.K. economy, in areas such as manufacturing and retail sales, shows that the country has rounded the recession corner. Forget the link to unemployment, the market is saying, if things continue like this one would have to raise the base rate sooner rather than later.

The government bond yield curve – still the original and best forward guidance indicator.

Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons 2012).

Featured