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Changes and divergences in monetary policy ‘will result in greater market volatility’

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Increased volatility in financial markets should be expected as both the US and Britain begin to unwind years of accommodative monetary policy, according to Michael Neff, executive vice president and head of group asset management at Butterfield who addressed a wealth management seminar in London.

Both the US and UK are experiencing better, more sustainable economic growth and their respective central banks will likely be reacting to these developments by beginning to increase base lending rates in 2015. 
 
The Fed Funds rate could be expected to rise as early as the middle of 2015, whilst Bank of England Base Rate is likely to begin rising as early as the first quarter of 2015.
 
Neff said UK rates “may rise less aggressively than in the US” owing to a more entrenched recovery in the US and in anticipation of the potential for further fiscal austerity in the UK.  Rates will rise gradually over a period of two years or more and pacing will largely be gauged by economic “facts on the ground”.  Both central banks would particularly like to see improvement in hourly wages, which still remain well below levels prior to the financial crisis.
 
Overall, the global economy will continue to recover, albeit at a modest pace. The International Monetary Fund recently trimmed its Global GDP forecast to 3.3 per cent for 2014 and 3.8 per cent for 2015. Both figures are well below levels witnessed before the financial crisis, though are in-line with Butterfield’s own growth expectations. Contributing to this downward revision in their forecast were signs that GDP growth in the EU was plateauing at approximately ome per cent, which is hardly robust enough to address chronic unemployment and debt issues across Europe.  Moreover, the threat of outright deflation remains an ongoing concern and the European Central Bank (ECB) will be forced to take more drastic measures than targeted credit easing and negative interest rates. Neff expects the ECB to move to outright quantitative easing (QE) or debt mutualisation in 2015.
 
Neff said the Bank of Japan, as with the ECB, has continued to follow an accommodative monetary policy and that QE purchases had the potential to rise in order to reignite inflation in the country.  As a result of the divergence in monetary policies in the developed world, he said clients “should expect to see appreciation in the US dollar and the UK pound and depreciation in the Euro and Yen.”
 
Against this macroeconomic backdrop, Butterfield Asset Management still favours equities over fixed income in the medium and longer term. Neff acknowledged that this positioning is “not as attractive as it was 12 -18 months ago” due to the run up in equity valuations, especially in the US.  However, given the expected rising rate in environment it remains the most constructive stance for portfolios with heavy US dollar and UK Sterling exposure.  In the equity space, consideration should be given to sectors that benefit in a rising rate environment such as financials and consumer discretionary.  In the fixed income space, Butterfield continues to favour exposure to corporate credit over sovereign, whilst limiting exposure to interest rate risk. Neff also noted that his team has been examining the non-traditional assets space for increased exposure.  

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