Central banks are becoming more influential.
That’s because many are now using alternative measures, says Luc de la Durantaye, first vice president of global asset allocation and currency management at CIBC Asset Management. He manages the Renaissance Optimal Inflation Opportunities Portfolio.
“This is a reflection of the challenging global economic environment,” he adds. “We have excess capacity in both the product market and employment market. This is what central banks are addressing with unconventional measures.”
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He notes the main goal of central banks is to influence short-term and long-term interest rates. But when banks lower interest rates to zero and give forward guidance, those measures only work for zero to two years.
If central banks want to influence longer-term interest rates and yield curves, he says, they also make asset purchases. The Federal Reserve and Bank of Japan have done this, and Europe’s central bank may soon make a similar move.
Overall, de la Durantaye predicts central banks will continue to be influential over the next 12 to 18 months. And for interest rates to rise, he says, there would have be “an improvement in both the excess capacity we have in the industrial sector…and, even more important, in the employment market.”
So far, there’s been some improvement in the U.S. market. “If that were to continue over the next three to six months,” he notes, “that could force…the Federal Reserve to change its approach [regarding] its monetary policy. That’s got to be on the radar of investors.”
In Canada, adds de la Durantaye, employment has been disappointing, which means the BoC will remain dovish. And “if we go around the world, unemployment is still so high in Europe that the ECB will remain very accommodative, at least for the next twelve months.”
Equities vs. bonds
If clients are torn between equities and bonds, help them compare each market’s performance. To do this, you can start by assessing equity markets and absolute valuations by looking at price-to-earnings ratios, says de la Durantaye.
Through analysis, you’ll find “equity markets are fairly valued to somewhat overvalued for the first time in a few quarters,” he adds. Meanwhile, fixed-income markets are more inflated.
Still, investors shouldn’t abandon bonds. Though equities outpaced fixed income significantly in 2013, he expects there won’t be as much of a performance gap this year.