Global market risks outlined

With the continuing and pronounced weakness in world trade prices and the still generally sluggish economic environment that has resulted in the US Federal Reserve Board (FRB) only tapering its current asset purchase programme modestly, then we can expect that the FRB will likely provide a further nearly $1 trillion of “cash flow” to the financial markets over the next year.

Presumably, as the FRB buys in yet more debt securities, it will create yet more of a “hole” in the supply of good quality bonds available to investors and implicitly force – or at least encourage – the vendors of these bonds to continue to re-invest their funds into either corporate bonds (thereby implicitly funding yet more corporate issuance and hence even more equity buybacks by companies), directly into equity funds, or into overseas assets. 

If the FRB tapers more aggressively in 2014, the risk markets in general and, we suspect, the corporate bond markets in particular would lose much of their recent support and the US might even face a severe “monetary cliff” without the FRB’s actions (since the FRB remains the only real source of liquidity growth within the economy at present) but it is not our belief that the FRB will do much more in the way of tapering than the USD10b a month announced in December. Given that we suspect that the forthcoming “Volcker Rule” will likely continue to prevent the US commercial banks from creating much liquidity to the system, this will presumably oblige the FRB to keep buying bonds.

Hence, the FRB’s actions will likely continue to provide some form of flow of funds foundation for asset prices.