Possibility of global crisis has resurfaced, panellists say

Global markets could be heading towards another financial crisis as central banks run out of ammunition to effectively stimulate growth, while conversation in the market has moved from policy normalisation to plunging deeper into the unknown territory of negative rates, panellists heard at the ninth FX Invest Europe conference in Amsterdam.

When speaking, panellists expressed their own views rather than those of their institutions, but a raft of high-profile speakers warned the Federal Reserve may have to reverse its policy path if conditions do not improve and they questioned the credibility of central banks.

"Negative interest rates seem to be perceived as somewhat desperate and everyone (central banks in developed countries) is playing the same game," said Guy Verberne, a senior macro strategist at PGGM Investments. "Central banks have lost credibility and I think what's happening is a race to the bottom, which is going to lead to a big crash in the future."

Panellists also questioned the effectiveness of quantitative easing (QE) and projected a repeat of the global economic slowdown.

"QE doesn't seem to be working," said Jeffrey Franks, a director at the International Monetary Fund. "The worry here is not about current QE, but about whether we are starting to turn down the business cycle and into the next recession with no bullets in the chamber in terms of policy."

Central banks have lost credibility and I think what's happening is a race to the bottom, which is going to lead to a big crash in the future
Guy Verberne, PGGM Investments

"For fiscal policy that chamber is empty because debt ratios are too high, and for monetary policy that chamber is empty because we already have zero interest rates," he added.

Franks felt the calling into question of central banks' monetary policies, such as QE and to a certain extent negative interest rates, is adding to market volatility. The fact that the very credibility of these policies is being contested only contributes to this further.

Panellists consistently remarked that this higher volatility environment was set to remain a feature of markets due to the economic slowdown globally, China, persistently low oil prices and the uncertain monetary policies of central banks.

"Over the past five years there's been an environment where volatility has been unusually low. We think this is coming to an end," said James Ashley, head of international market strategy at Goldman Sachs Asset Management.

"We're not saying the turmoil we've seen in financial markets since the start of the year is likely to persist at this level of magnitude, but we do think the low levels of volatility we've seen across most asset classes over the past few years are unlikely to return. We need to adapt to a high-volatility environment," he added.

Ashley noted the Fed expected to carry out as many as four rate hikes this year, but market expectations do not predict further increases.

The low levels of volatility we've seen across most asset classes over the past few years are unlikely to return. We need to adapt to a high-volatility environment
James Ashley, Goldman Sachs Asset Management

Questions arose over the credibility of pegs and the ability of central banks, particularly in the Middle East, to maintain their currencies' exchange rates linked to the dollar.

"The question in the medium term is: how long will oil exporters be able to hold their dollar pegs?" asked Kaan Nazli, a senior economist at Neuberger Berman. "Maybe in three years' time this will become a big issue."

While G10 monetary policy may have been an important driver of volatility in recent years, China has certainly contributed its share to the recent turmoil.

"There's a new kid in town called China, which produces more than 15% of global gross domestic product (GDP) while emerging markets produce 50% of global GDP. When there is a problem with these markets it's not easy to ignore them," said Onursal Kilic, lead portfolio manager for emerging market debt at pension administrator and asset manager MN.

For Ashley, the unprecedented rebalancing and opening up of China's economy is certainly creating volatility and uncertainty.

"It's not just a cyclical issue, there's also a structural issue. China is getting richer. As economies get richer, they tend to switch more of their economy into services," he said. "Higher levels of service output tends to be associated with lower levels of GDP growth. For us, China is going to go through a structural and cyclical slowdown, with potential GDP growth heading down to 5.25% on a multi-year horizon."

China still has a lot to [do to] catch up. And urbanisation and consumption per GDP in China is nowhere near some emerging market countries
Onursal Kilic, MN

While the slowdown in China may be inevitable, Kilic said the country needs plenty of growth if it is to catch up with its western – and even emerging market – peers.
"When looking at parameters like capital-stock-per-capita versus GDP-per-capita, China still has a lot to [do to] catch up. And urbanisation and consumption per GDP in China is nowhere near some emerging market countries," he said.

All indicators point towards an overvalued yuan, said Kilic, but the bigger question is how China will go about correcting it.

While Donui Agbokou, chief strategist at APG Asset Management, believed China's authorities knew what they were doing when they previously devalued the yuan, she says they simply lacked the experience of communicating it to the world.

"The Chinese probably did the right thing," said Verberne. "The switch to a more effective exchange rate is a wise thing to do. They did the right thing, but just did it in a bad way. They didn't explain it very well, which, of course, adds to volatility. At some point they will learn to communicate with markets. In the meantime we're going to be stuck with this volatility."

The persistently low oil prices have contributed their fair share to global volatility and uncertainty, particularly for commodity-exporting countries in emerging markets. "Because we haven't convincingly found a bottom in the oil price and generally on commodities, we tend to be more cautious on EM FX going forward," Nazli added.