In spite of an uncertain economic backdrop risky financial assets have prospered at the expense of safe ones.
Since June 2012 US Treasury bonds, widely seen as one of the ultimate safe assets, have fallen by 1 per cent while US equities have risen by 17 per cent. In the currency world the usual safe havens of the US dollar, the yen and the Swiss franc have lost ground to the euro.
By and large the riskiest assets have seen the greatest increases in value. High yield UK corporate bonds have returned 26 per cent since June while UK government bonds have fallen by 2 per cent.
The debt of peripheral euro area countries has risen sharply in value, with Greek government debt up 274 per cent since June.
Investors seem to be increasingly confident that policymakers will avert another global meltdown. The past six months has seen the launch of a wave of new measures across the world designed to keep growth going.
The European Central Banks has said it is ready to buy at-risk government bonds without limit. The US and UK have undertaken further rounds of quantitative easing. Japan and China have loosened monetary policy. The US has managed a temporary fix to its debt crisis, Japan’s new government has announced a huge public spending programme and the Basel III rules for bank capital have been eased.
However, the fact the market has liked what it has seen does not necessarily mean the global economy is out of the woods. The market changes its mind. In 2010, 2011 and 2012 there were big equity sell offs triggered by bad news from the euro area. In 2011 the US debt crisis played a major supporting role in the sell soff. On each occasion equities bounced back.
The hope is that the risk rally signals an improving outlook globally. Policymakers see financial markets as a vital channel through which easier policy is transmitted to the real economy.
Today’s rally has so far not been accompanied by an improving economic outlook. Global growth forecasts have fallen in the past six months and business confidence is weaker than financial market confidence.
It may be that the current rally has more to do with a perceived reduction in the risk of catastrophic economic shocks – such as the breakup of the euro or a US default – rather than an improving outlook for growth. History demonstrates the performance of financial markets and economies do not move in lockstep.
Stronger financial market risk appetite should be positive for economic activity. But this is not the sole or most important determinant of growth. And, as the past five years demonstrate, such rallies are vulnerable to setbacks.
Ian Stewart is chief economist at Deloitte
