04.13.2015
By Terry Flanagan

Monetary Policy Divergence Drives Volatility: Report

Monetary policy divergence is driving volatility in local asset values in markets around the world and investors should prepare for this volatility to continue, according to a report by Manulife Asset Management.

As a result of the developing environment, U.S. equity investors will need to be especially focused in their search for growth, for example by analyzing opportunities in higher organic growth sectors such as technology, health sciences, and those with a greater domestic footprint such as small caps, the report said.

Fixed income investors may need to look further along the credit spectrum towards higher yielding securities or to examine new geographies such as emerging markets. While developed markets such as Canada, the UK and Sweden may be “placeholders of quality” in this environment, the report also identifies as opportunities fundamentally strong emerging economies with current-account surpluses such as Singapore, Thailand, Korea, the Philippines, Brazil and Mexico.

In January, the Bank of Canada surprised markets by cutting interest rates by 25 basis points to 0.75% with Governor Stephen Poloz citing continued concerns about the negative impact of low oil prices on the Canadian economy as the key driver for the decision.

With Brent Crude Oil prices languishing in the low $50s and its West Texas Intermediate (WTI) counterpart in the low $40s, the Canadian bond market is rallying strongly on hopes of a further rate cut as soon as April, according to Terry Carr, head of fixed income, Canada at Manulife.

“While the U.S. monetary decoupling from the rest of the developed world is a subject of global interest, it’s worth examining the implications of the microcosm of divergence that is happening right on the US’ doorstep,” Carr said in the report. “The precipitous fall in oil prices, while challenging for Canada, has been broadly positive for the US economy.”

As a consequence of these dynamics, a highly unusual North American decoupling situation is developing: US and Canadian rate policies typically march in lock step, with only minor and short-lived variances from their mutual monetary path. This new situation, with the US likely tightening and further easing expected north of the border, potentially puts investors in uncharted territory, Carr said.

Typically, countries adjust to a lower growth environment with some combination of fiscal stimulus and monetary easing,” said the report. Global demand slowdowns combined with fiscal austerity have put an outsized burden on monetary policy and driven many countries to fight for competitive position and export share through lower currencies – an undeclared currency war, said the report.

The U.S. having taken most of these steps early in the cycle, is now in a relatively strong economic position which allows it to let its currency appreciate and to consider rate increases.

“Ironically, this ‘winning’ position puts U.S. growth and U.S. export share at the mercy of aggressive currency devaluations by other countries. However, we believe the U.S. economy is in robust-enough shape to withstand this forex fracas,” the report said.

Featured image by Eisenhans/Dollar Photo Club

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