Editorial: Rising interest rates a reality check for stockmarkets

Editorial

Thanks to Waitangi Day, the New Zealand sharemarket was spared the panic that can seize traders everywhere when Wall St sneezes. By the time the NZX opened yesterday the New York Stock Exchange had recovered overnight and the word on commentators' lips was not "cash" but "volatility".

The prognosis seems to be that stock prices are entering a period of greater fluctuation after their long bull run that started since soon after the 2008 global financial crisis.

Like housing and other equity investment, stockmarkets have benefited from extremely poor returns on other forms of saving as interest rates were kept low in leading economies to help them weather the post-crisis recession.

Interest rates even went below zero in some places, effectively punishing savers for not spending. And when near-zero rates proved to be not enough in the United States and Europe their central banks began "quantitative easing" — buying their government's bonds and flooding their economies with cash.

This artificial — and dangerously inflationary — antidote to recession was not expected to last as long as it did. Keynesian theory is not precise about how long monetary and fiscal stimulants may be needed. This one seemed to be needed for the best part of a decade.

It may be argued that monetary loosening had to bear too much of the burden and governments, particularly in the US and Germany, ought to have run deeper fiscal deficits after the crisis. Whatever the reason, quantitative easing lasted far longer than was probably intended.

Once major economies were on this form of life support it proved very hard to take them off it. The US Federal Reserve failed at its first attempt, hurriedly suspending a plan to phase down its bond purchases when signs of economic growth faltered after its announcement.

Two years ago, with employment and growth picking up, the Fed finally withdrew the life support and began gently raising its interest rate. Now European economies, too, are looking strong and even Japan, which lived on quantitative easing before the crisis, no longer needs it.

In these circumstances equity markets are almost certain to be destined for a "correction". And it is not just the usual correction of over-shooting prices on a normal cycle, this one will be an adjustment to a more fundamental correction of monetary management in their economies as interest rates return to normal.

Stockmarkets will expect interest rates in the US to rise faster and higher as a result of the Trump Administration's tax cuts and big spending plans for infrastructure and the military.

This threatens to be an ill-timed budget blowout that will require counter inflationary efforts by the Federal Reserve. Wall St's plunge on Monday was bound to happen sooner or later and it is probably the beginning of a turbulent downward trend.

The New Zealand market, which dropped 2 per cent on Monday, fell only 0.8 per cent on yesterday's morning trading.

This economy was well cushioned for the global crisis by budget surpluses and did not need unorthodox monetary stimulants. Consequently it does not face the same corrections now. But the charmed ride for all stockmarkets looks to be over.