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‘Policy Error’ More Risky Than Oil for Scottish Money Managers

Aberdeen Asset Management Strategy Head Mike Turner
Head of global strategy at Aberdeen Asset Management Mike Turner. Source: Aberdeen Asset Management Plc via Bloomberg

Financial markets are more at risk from policy makers getting spending and interest rates wrong than rising oil prices, according to investment strategists in Scotland overseeing about 530 billion pounds ($850 billion).

The timing of interest rate increases in developed economies, China’s response to accelerating inflation, the European debt crisis and tackling the U.S. fiscal deficit all pose bigger threats to markets than this year’s 20 percent jump in the cost of Brent crude, they said.

“The biggest risk out there still is the risk of policy error,” Andrew Milligan, head of global strategy at Standard Life Investments, Edinburgh’s biggest fund manager, said in an interview. “There are numerous policy decisions that need to be taken for our central scenario of ‘steady as she goes.’”

Borrowing costs are rising in emerging markets such as China and Brazil to counter inflation, while European Central Bank council member Jozef Makuch said yesterday a euro rate increase next week is “highly probable.” Policy makers in nations including Britain are concerned action to curb consumer price increases might lead to weaker economic recoveries.

Aberdeen Asset Management Plc, Scottish Widows Investment Partnership and Aegon Asset Management are also concerned that the recovery in the global economy could be ambushed if policy makers raise interest rates too quickly.

Rate Expectations

“Investors have become accustomed to very low interest rates and that’s my main concern,” said Ken Adams, head of strategy at Scottish Widows Investment, the Edinburgh-based fund unit of Lloyds Banking Group Plc.

Adams, who spoke on March 23 at Bloomberg’s Edinburgh office in discussion with Milligan and Mike Turner, head of global strategy at Aberdeen Asset Management, also said the greatest threat to markets is “policy error.”

The Bank of England has held its benchmark interest rate at a record low of 0.5 percent since March 2009. Analysts polled by Bloomberg News expect the cost of borrowing to rise to 1 percent in the fourth quarter of this year. The U.K.’s Office for Budget Responsibility last week cut its forecast for growth for 2011 and 2012.

Economists expect the Federal Reserve’s target rate to remain 0.25 percent through 2011, while the ECB will push its main refinancing rate up to 1.75 percent from 1 percent by the end of the year, according to estimates compiled by Bloomberg.

“There are very significant risks to the relatively sanguine view investors are taking,” Bill Dinning, head of strategy at Aegon, said in a separate interview on March 25. “Twenty emerging-market countries had raised interest rates when I looked, and that creates policy risk.”

Scottish Funds

Aberdeen’s assets rose 27 percent to 183 billion pounds at the end of 2010, while Standard Life’s funds went up 13 percent to 157 billion pounds. They advanced 3.2 percent to 146 billion pounds at Scottish Widows Investment. Dutch insurer Aegon NV’s U.K. fund business managed 41 billion pounds from Edinburgh on Dec. 31, 14 percent more than a year earlier.

Rising interest rates in the fastest-growing economies doesn’t necessarily mean stocks are entering a “big bear phase,” Turner at Aberdeen said.

“I don’t think the valuation of stocks is particularly demanding,” Turner said. “Just in terms of yield competitiveness with other assets, the competing asset class angle means there’s always the realization that if there’s a dip in equity markets it makes them even more competitive.”

Adams agreed that there was still value in stocks, especially relative to bonds.

“The question now is do we respond to this sell-off, do we have an opportunity to replace risk, what the size of the position should be,” Adams said.

Bond Yields

The biggest strategic worry is the level of government bond yields, which Turner said are still too low. U.S. 10-year Treasuries yield about 3.45 percent, down 10 basis points from three weeks ago before an earthquake and tsunami hit Japan’s northeast coast. Yields should be 4 percent to 4.25 percent, Turner said.

The lingering effects of the global financial crisis, rising concern about European sovereign debt, increasing political turmoil in the Middle East and North Africa and the disaster in Japan are all making it tougher to navigate markets.

“We are starting to see the deceleration of global growth,” Milligan said. “China tightening and oil tightening is not a great combination.”

Controlling inflation is its main task, the People’s Bank of China said on its website after the quarterly meeting of the central bank’s monetary policy committee.

Faster Inflation

The world’s second-largest economy had consumer-price inflation of 4.9 percent in February, higher than in any of the Group of Seven nations. The central bank has raised interest rates three times since October.

Oil prices have risen 37 percent in the past six months to about $105 a barrel. That’s paring consumer spending and will reduce company profitability later this year, prompting Aegon to reduce its “overweight” position in Asian and U.K. stocks this month, keeping the money in cash, Dinning said.

“The potential rolling over of activity combined with the oil price is a risk,” Dinning said. “We have close to zero rates and you’ve never seen this before. It might be some time before we know all the consequences.”

It’s not clear how much markets have priced in the prospect of slower earnings growth, Milligan said.

“The world economy is going well but if big policy errors came along, markets wouldn’t be correctly priced at all,” he said. “Are the Chinese going to make policy errors in all the issues that they face? What on earth is America going to do with its fiscal deficit? Can European politicians get their act together on the debt crisis?”

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