The Lowdown on Markets to 10th March 2017
World Markets at a Glance
In this week’s issue
- The global economy has started 2017 with strong momentum and conviction.
- In the US the latest non-farm payroll figures support the recovery within their economy.
- Even in Europe the ECB president, Mario Draghi, seems to have become more positive.
- In the UK the prime minister is getting ready to invoke Article 50 freeing us from the EU.
- The Federal Reserve Bank should raise rates this week but the wording will be crucial.
- Markets should remain buoyant even if we experience a short-term pull-back.
“Global markets start to focus on higher rates, inflation, and Article 50”
Whilst the global equity markets have rallied on the “Trump trade”, it has also been noticeable that the global economy has started 2017 with strong momentum and conviction, as business surveys, and economic data has begun to signal much better or robust growth. Clearly, the US economy is leading the way and Fridays US non-farm payroll numbers supports that statement by seeing a rise of 235,000 jobs for last month, which easily beat the consensus forecast of a 190,000 job increase. Similarly the US jobless rate fell to 4.7 per cent from 4.8 per cent, whilst the year-on-year wage growth rate rose to 2.8 per cent from 2.6 per cent.
Clearly, this recent news will almost certainly mean that the Fed chair, Janet Yellen, will announce a further US interest rate hike at this week’s two day Fed meeting. But of course, most traders would have already seen the market anticipate this over the last few days. Therefore, what market analysts and investors will now be digesting is Ms Yellens statement and wording in respect to how the Fed interrupts the current positioning of the US economy, what future effects outside forces might have over the coming months, and of course, the new US administrations economic policies.
“We have already seen the Federal Reserve Banks original targets now fulfilled”
Given that we have already seen the Federal Reserve Banks original targets now fulfilled it is just a matter of the US central bank navigating a steady course knowing that they might experience some turbulent times ahead under “Trumponomics” and perhaps some further political surprises in other parts of the world. Arguably, the markets will also try to interpret how many more interest rate hikes could be expected this year with the general consensus being two to three, with a similar number for next year.
However, much could depend on whether the current strength of the recovery is sustainable, given that the recent economic support that has been behind the recovery might begin to weaken as the inventory cycle turns and rising inflation begins to erode the purchasing power and spending of the consumer. Admittedly, recent optimistic economic signs out of the emerging markets, Japan and the UK could help to offset any short-term weakness that we might experience out of the United States over the coming months, but much could depend on the promises given from US president Trump.
“Even the ECB president, Mario Draghi, seems to have become more positive on the outlook for the European economy”
In fact, even the ECB president, Mario Draghi, seems to have become more positive on the outlook for the European economy, apparently, declaring victory over deflation, and perhaps moving nearer to winding down the central banks ultra-loose monetary policy. At the same time, whilst the ECB are likely to keep rates low over the short-term, the bank did seem to be indicating that they no longer have that sense of urgency that they once had, which in turn, created a change in the investment mentality of FX and bond traders which led to the euro strengthening whilst the benchmark yield on the 10-year German Bund reached its highest level since early February.
Then after the ECB meeting Mr Draghi spoke to the press saying that the central bank were not planning to unleash another round of cheap bank loans and that because of the improving economy, he had dropped a sentence from his remarks that referred to the ECB’s readiness to use all of the instruments available in its mandate, if warranted. Understandably, this unexpected hawkish stance by the ECB was probably welcomed by those Bundesbank hawks back in Germany. Indeed, the initial response from the market was to price in a 68 per cent chance that the ECB will raise Interest rates by August 2018 – up from 31 per cent in the previous week.
Nevertheless, the central bank is unlikely to tighten until it withdraws from its current quantitative easing programme, which is €60 billion per-month, and on that delicate point, the ECB president did successfully side step that particular question at the press conference. But then again, one could say that this new central bank posture might be leading us to further QE tapering announcements after those important elections in Holland, France and Germany, especially, if recent growth and inflation rates follow their current paths.
This leads us nicely onto the subject of Brexit, and the invoking of Article 50, clearly, the European leaders are preparing for the UK Prime Minister, Theresa May, to activate this procedure and begin the divorce proceedings, which will obviously create a further period of uncertainty in the market place. In Europe, many of the EU leaders believe that the British people did not make a good choice by voting to leave the European Union, whilst Mrs May prepares to fulfil the British voters decision and activate proceedings. In Europe, Angela Merkel, the German chancellor, has said that if the UK triggers Article 50 as early as this week, then the other EU-27 leaders could meet on the 06th April 2017 to agree the guidelines for the UK’s exit talks.
“This would suggest that traders are expecting very little volatility in the short-term”
Now moving on from the political and economic landscape, to last week’s market moves. Firstly, we are still seeing an incredibly low Vix Index reading, which closed at 11.73, compared to much higher levels last year, and a long-term average of almost 20. This would suggest that traders are expecting very little volatility in the short-term; in fact, they tend to expect stock to rise when there is low vol.
Indeed, there is probably enough good news in the market place at the moment to support the level of the global equity markets, and if the US central bank raises interest rates this week, followed by an optimistic slant from Ms Yellen, then they may indeed trend higher. However, the asset classes that are likely to be under the most scrutiny will be the bond markets, and the crude oil price, given that they are both very sensitive to the current changing landscape of higher interest rates, inflation, and an uncertain political backdrop, which in themselves could create very different outcomes for the markets depending on their successes or failures towards stronger or weaker economic growth.
Looking forward, conditions remain positive for riskier asset classes as economic activity continues to gain momentum in both developed and the developing world. Clearly, the political backdrop will remain uncertain over the next few months with Brexit adding to the mix. However, the business cycle indicators continue to support positive investor sentiment with global equities looking more attractive than bonds. In respect to regional preferences, Europe, Japan and the emerging markets look cheaper than the US, but it’s the best performing economy at the current time, characterised by strong consumption and a rebound in investment.
Finally, we have just passed through the eighth anniversary of this current bull market; therefore, we fully expect to experience a meaningful pull-back in the near-term but it is likely that this will be met by a wall of new money which has either been sitting on the side-lines or we see an escalation of the rotation out of bonds and into selective equities and sectors.
Peter Lowman Chief Investment Officer
Peter Lowman Chief Investment Officer Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority .