Volatility expected in bond mkts, not equity mkts: JP Morgan

Equity markets are not as impacted by interest rate changes as bond markets are and hence, some turbulence in latter is expected in period ahead, says James Glassman, Senior Economist at JP Morgan. Speaking to CNBC-TV18, Glassman says that actions of central banks are impacting bonds market. US 10-year- yield has hit record lows of 1.36 percent. Market, however, is more conducive for equity investors. On US, Glassman says that the economy is doing well despite the recent slowing job data. The Federal Reserve is likely to raise rates before end of current year. Below is the transcript of James Glassman’s interview to Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: What a strong run for equity markets globally and you are reading into the fact that we had such strong data. The bond yield is at a low and the equity market is close to lifetime highs.A: What is going on in the bond market is more about what central banks have been doing and the worry about the Brexit event. So, after Brexit, the markets repriced a more cautious central bank view. The truth is and the equity markets seem to think that there is enough response from the central banks that would offset that. And meanwhile, the jobs data tells you that there was no reason to take seriously the weak employment report that we saw back in May. The trend is similar to other things that we are seeing. Yes, the jobs growth pace is slowing down very gradually, but that should be expected as the US economy approaches, gets closer to full employment. So, if it were not for the Brexit event, my guess is that we would be talking more about the Fed, maybe not July, but the next meeting is now a possibility because the trends in the job market are telling you that the US economy is still doing fine and the weakness that we saw that worried the Fed is looking like aberration.Sonia: It is only once in the last 40 years that we have seen this kind of a situation pan out where equities are at record highs and bond yields are at record lows. What does this tell you about the turf of the market here on? Do you get a sense that we could be in a goldilocks environment where the domestic US market is picking up and at the same time, there is no fear of the Fed raising rates because of global uncertainty? Does this make it very conducive for equity investors to increase allocations?A: there is plenty of reasons for equity investors to be happy given what is taking place globally. Growth will slowly pick up. But the thing to remember is central banks, the asset purchases that central banks are doing have really created new distortions in bond markets that are very difficult to sort out. So, for example, between the Japanese-US earlier, Europeans, Bank of England and Sweden, they have already taken out USD 10 trillion of securities from the markets. And between the Japanese and the Europeans are already taking USD 2 trillion, removing them from the markets. So, part of the problem here, one reason why the bond market is behaving the way it is, is because of these actions from central banks which is really quite unique. We have not seen this ever and it may be contributing to the unusually low yields. For example, key central banks tell you, they are aiming for two percent inflation. Why would anybody want to hold a fixed income security that is offering a nominal yield below that 2 percent inflation target and that is just a reminder that there are a lot of unusual things happening here. It may not be a statement about global activity. It may be just the impact of removing assets from the markets. So, I do not think that removes the Fed from the process of having to slowly normalise interest rates and I do not think it is a threat to the markets. Frankly, as long as what is driving the Fed is promising growth prospects and eventually, if the Brexit event does not do much damage to the European economy, then this is not a bad backdrop for the equity market.Anuj: How high is the risk that the market is being a bit too complacent right now, whether you look at the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) or whether you look at the fact that the markets are globally back to pre-Brexit highs, in fact some of the markets are 3-4 percent higher than pre-Brexit highs? Could that come back as a bit of a risk to haunt equity markets at some point in 2016?A: It may come back to haunt bond markets for sure because these deals really do not seem consistent with longer term fundamentals. Now of course, that is a challenge for the equity markets, but as long as equity markets are not really threatened by normal interest rates. Right now, what is really unusual is bond yields and there could be turbulence in the future when the events that are driving bond yields to really unusually low levels and inconsistent with longer run inflation targets which central banks have, there could be a period of turbulence ahead. I do not know if it would be that much of a threat to the equity market, as long as it is not a threat to global growth prospects. So, it is more the bond markets that is facing the challenges.Sonia: What is your own expectation of the Fed move? Do you think that a rate hike could happen by December this year or have you moved your expectations to next year?A: I do think it could happen. The signs in the US economy looks steady and it was only a month ago that Fed people were beginning to warn the markets that they were thinking about another move and then we got that very disappointing May jobs report which is now looking like an aberration. So, it is likely that the Fed will take another stab before the year. And frankly, that would be a positive thing for the markets because if we wait around till it is obvious that rates need to normalise, it could become much more volatile for the fixed income markets. So, I expect that to happen, I think it would be very steady and gradual.