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Central banks eye rate cuts to reduce volatility

Efforts by central banks to “dampen volatility” could backfire and make “the financial ecosystem much more fragile”, a fund manager at RWC Partners has warned.

His comments came after the UK joined other countries in cutting interest rates in a bid to reduce market volatility following the coronavirus outbreak.

But not everyone shares his opinion and asset managers are divided about how impactful these cuts will be.

Just the start?

John Vail, chief global strategist at Nikko Asset Management, said he expects even more rate cuts going forward.

“The Fed will likely cut another 50 basis points (bps) in March, while the European Central Bank and the Bank of Japan will likely cut by 10bps, but make lower rates more palatable for banks.

“All three central banks will very likely also announce new liquidity programmes targeted at SMEs and industries affected by the virus.”

The Bank of England (BoE) has already announced an emergency rate cut by 50bps to 0.25% to bolster the economy.

The news comes against the backdrop of more volatility hitting financial markets.

Brendan Walsh, senior vice president/portfolio manager at Franklin Templeton, said, in his view, “it’s possible in the near term that there is still more downside for equity markets and upside for volatility”.

Opinions on central bank measures

But observers are undecided whether the step by central banks to dampen volatility will have a positive effect on the markets.

Commenting on the BoE interest rates cut, Artur Baluszynski, director and head of research at Henderson Rowe, seemed sceptical.

“There is very little the BoE can do to repair the damage done to the economy by Covid-19, so they are doing the only thing they can – starting to ease and lubricate the financial system,” he said.

Walsh, however, sees opportunities for investors from a coordinated response.

“The likelihood of a global recession depends on the response from governments and central banks to the virus, as well as the duration of the outbreak.

“As with 2008, for investors who can navigate the volatility, there will be many great opportunities which may be boosted by easy financial conditions. Coupled with coordinated fiscal action, the clearing out of positions is likely to be very positive for risk assets longer term.”

Ian Lance, fund manager at RWC Partners, sees markets weakening if central banks continue to act as a safety net.

“Central banks have sought to dampen volatility, but have made the financial ecosystem much more fragile. By continuously intervening at the first sign of a market correction, they send the signal that they will always backstop the market and thus encourage businesses and investors to take excess risk.

“The build-up of these type of risks makes the financial system more fragile. It is impossible to know what event will trigger a sudden reversal in markets,” he warned.

Lance added that market declines can lead to a healthy correction in risk taking.

“Periodic market declines warn investors against taking too much risk and prevent more severe crashes.”

Elena Johansson

Senior Reporter

Part of the Bonhill Group.