The Lowdown on Markets to 21st October 2016
World Markets at a Glance
In this week’s issue
- Divergence across central banks continues to provide markets with directional issues.
- In Europe the ECB gives a non-committal statement on their QE programme extension.
- Equally, the Federal Reserve Bank is holding back from any interest rate decision.
- The UK sees its inflation rate rise to 1.0 per cent, its highest level for almost two years.
- In the FX market both the euro and sterling come under further pressure.
- Whilst the rally in riskier assets shown signs of fatigue investors still remain upbeat.
“The central banks appear to be sending out a wait and see message”
Once again, the markets and its investors are trying to predict what the leading central bankers around the world might do next in respect to their individual monetary policies, especially when many of their domestic economies, and indeed to global economy, still appears to be showing signs of lacklustre growth.
Last week in Europe the president of the European Central Bank, Mario Draghi, seemed rather non-committal on whether the authorities will extend their quantitative easing programme beyond the month of March 2017, in fact, he went on to say that at their last two day policy meetings, the bank had not even discussed the question of whether they would taper, or announce an extension of the institutions bond buying programme. This in turn, saw the euro fall to its lowest levels since March which I’m sure would have pleased Mr Draghi.
Arguably, the ECB president did say that their statement and decision in early December will tell the financial markets what they plan to do over the coming months, and whilst the ECB’s balance sheet has already swelled to almost €3.5 trillion, a record high, it is very unlikely that they would begin to unwind their tapering programme, indeed it is more likely that they will extend their bond purchases beyond March, but perhaps tweak the rules of the monthly purchases to ensure that they do not run out of bonds to buy.
“The UK government will be invoking Article 50 sometime in the first quarter of 2017”
Also the ECB are fully aware that the UK government will be invoking Article 50 sometime in the first quarter of 2017, which will undoubtedly “muddy the waters” in the financial markets, given that the prime minister, Theresa May, has already indicated that the UK’s exit from the European Union is likely to be a “hard Brexit”. Furthermore, the ECB’s inflationary target is yet to be achieved leaving them very little option in respect to making aggressive changes to their current monetary policies.
Similarly, in the US the Federal Reserve Bank seems to be holding back on any further decisions on interest rate hikes given that they currently seem to be between a “rock and a hard place” trying to weigh up the present-day US economic data against the unpredictability of the outside forces in the global economy. Also they do have the conundrum of a US presidential election result in November where both candidates seem to be unpopular choices from the electorate perspective.
And of course, from a UK viewpoint, the governor of the Bank of England, Mark Carney, has already taken evasive action, post Brexit, by cutting UK interest rates and announcing a further bond buying programme to offset any immediate economic effects that the decision to leave the European Union might have on the UK economy. Clearly, this has already taken its toll on the pound where we have seen sterling depreciate by just over 17 per cent since the vote in June and a spike up in UK inflation.
Clearly, the latter is something that all three central banks have been trying to kindle for some time through variable monetary policy strategies, but so far all would seem to have failed. Yet, recently there would seem to be a change of direction in the US and more importantly the UK. Indeed, the September data is showing that UK inflation has actually spiked up from 0.60 to 1.0 per cent, which is its highest level for almost two years.
Arguably, the effects from a weaker pound has been the main factor for its rise given that imported goods are now costing the consumer much more, UK imports of petrol, food, electrical goods and even high street fashion prices have already risen, or are likely to do so, in the not too distant future.
“Both candidates seem to be unpopular choices from the electorate perspective”
Obviously, quarrels between UK supermarket groups and international suppliers have already been reported in recent weeks projecting the theory that if inflation were to rise further over the coming months then the issue of pricing wars could gain some momentum. Understandably, any price rises that feeds through to the consumer could then lead to a rise in the cost of living and possibly wage inflation, however, historically, when inflation begins to rise, then so do interest rates.
Regrettably, both the UK consumer and saver might be faced with a new set of problems on this occasion. Firstly, we are unlikely to see interest rates rise in the foreseeable future; in fact, there could even be further cuts given the Bank of England’s recent comments that they will remain in easing mode in case the UK economy struggles from a “hard Brexit”.
Secondly, the governor of the Bank of England, Mark Carney has already said that inflation will rise on products such as food, goods and services over the next few years, because of the plunge in the pound, which could make it difficult for low income earners. He then added that the central bank would tolerate a bit of an overshoot on their inflation target, which currently stands at 2 per cent.
“Bonds are the asset class to avoid”
Clearly, sterling has taken a beating since the European referendum result, and of course, we could see the pound fall even further, as and when the government get around to invoking Article 50.This in itself has led to some economists starting to predict that inflation will hit nearer 3 per cent by the end of next year which will make imported goods even more expensive. However, on the flip side of higher inflation comes the benefit from the exporters as they should see a rise in corporate profits.
Understandably, bonds are the asset class to avoid and we have already seen prices of government Gilts recently fall, whilst yields have risen, which would seem to signal that bond traders are already pricing in the probability of higher UK inflation, and of course, we are seeing investors begin to add some protection around their portfolios in the form of index-linked bonds, and “real assets” such as property, commodities, and infrastructure which do tend to rise in line with inflation. And in respect to sectors the attractiveness of utilities, healthcare and energy stocks are likely to be beneficiaries given that their prices tend to rise in line with inflation.
Obviously, this is likely to create further difficult times for income seekers and savers given that cash in the bank, in cash ISA’s, or under the mattress, will eventually be eroded by higher inflationary pressures, and therefore, seeking out opportunities to capture acceptable levels of return, without taking on higher levels of risk, will become even more challenging over time.
“It is very likely to see investors begin to navigate a different course of investment strategy”
This in itself has recently led to the likes of Lord William Hague voicing an explosive attack on the central banks, and in particular the Bank of England, suggesting that Britain’s current ultra-low interest rates, and quantitative easing , effectively printing money will create discord and pave the way for a crash in the markets. Clearly, this is the risk that the markets are facing but this is unlikely to happen until central bank policies change direction and begin a period of tightening.
Although, we are likely to see interest rates tighten by a small margin in the US over the coming months, it is not conceivable to see rates rise in either the UK or Europe in the foreseeable future however, it is very likely to see investors begin to navigate a different course of investment strategy to accommodate a rise in inflation, a possible stronger US dollar, a hard Brexit, and further political uncertainties across Europe.
Last but not least, whilst riskier assets such as equities have recently shown some signs of fatigue, as global investors begin to focus themselves upon the outlook for future central bank policy, they still remain upbeat, even if they are a little more cautious about their asset allocation positioning.
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 .