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'No equity bear market but more corrections' seen by Citi strategists

  • Synchronized tapering of global central bank stimulus programs could prompt more volatility in equity and corporate and sovereign bonds, Citi global macro strategists said.
  • Exploring current market themes, Citi's strategists said there was no need for a "bear market."
  • When there was synchronized tightening, Citi's strategists said that "equities can remain in a bull market if the tightening reflects higher growth, nominal or real."
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Synchronized tapering of global central bank stimulus programs could prompt more volatility in equity and corporate and sovereign bonds, Citi global macro strategists said in a research note Monday.

Exploring current market themes, Citi's Jeremy Hale, Maximilian Moldashl, Amir Amin, Jamie Fahy and Skylar Montgomery Koning added that there was no need for a "bear market."

Synchronized reductions of asset purchases by central banks, a process known as tapering, and the tightening of monetary policy, increasing interest rates, had several implications for markets, they said.

"Of course, only the Fed (U.S. central bank) is acting to reduce its balance sheet yet. The ECB (European Central Bank), BoJ (Bank of Japan) etc. are merely expanding the balance sheet at a slower pace than before. But the flows are easing into asset markets," the strategists said.

"Monetary tightening via interest rates is also still mainly a Fed story so far with sporadic support elsewhere."

Nonetheless, when looking at the implications of "synchronized tapering" by other central banks, the strategists said there was a "high likelihood of equity market corrections, though not necessarily greater than in pre-taper periods" and "higher implied and realized volatility of risk assets including equities and both corporate and sovereign credit spreads."

However, they believed there was "no need for an equity bear market."

The strategists noted that ECB tapering would drive euro appreciation as a result of reduced flows of foreign investment funds to the rest of the world, especially the U.S. "The latter likely adds to upwards pressure on U.S. yields and U.S. corporate credit spreads," they said.

Synchronized tightening

Looking at the potential market implications of "synchronized tightening" of monetary policy — the hiking of interest rates by central banks that is widely expected as the global economy improves — Citi noted that so far synchronized tightening was not yet visible.

"So we have tapering but not tightening so far, but the latter is coming," they said.

Only the Fed and Bank of England have started slowly raising interest rates and the majority of economists believe the BOJ and ECB will hold off hiking rates until at least 2019, unless inflation rates rise much faster than expected.

Citi defined synchronized tightening as "average policy rates rising and more than 60 percent of central banks involved" and didn't expect such a state to exist until around the third quarter this year.

When there was synchronized tightening, Citi's strategists said that "equities can remain in a bull market if the tightening reflects higher growth, nominal or real."

Synchronized tightening would cause bond yield curve dynamics to change in Europe and the U.S.

"In the early phase, the U.S. economy (and Fed) leads. The U.S. curve flattens as the Fed hikes. Later, when others join in, the heavy lifting is shared in slowing global growth/inflation risks. A few months in, front end U.S. yields peak and the curve stops flattening in the U.S. But in Europe, flattening remains strong," the strategists said.