The Lowdown on Markets to 2nd September 2016
World Markets at a Glance
In this week’s issue
- Whilst the Fed continues to talk about raising short-term rates will that happen this year
- Another disappointing month for US jobs could discourage the Fed in taking any action
- Both global equity and bond markets continue to react positively to central bank policy
- China’s PMI figure surprises and reassures both the equity and commodity markets
- In the UK the Prime Minister re-affirms that Article 50 will not be invoked this year
- Both Asia and the emerging markets deliver the best global performances over August
“Global equity markets move higher on soft US job numbers”
The recent build up to the Fed’s summit at Jackson Hole Wyoming heard the Fed chair, Janet Yellen; speak about the case for an increase in short-term interest rates saying that the US economy had strengthened over recent months, given that they had already seen steadier jobs numbers, and a moderate outlook for US growth. She also spoke about the probability for US inflation to reach the Fed’s target of 2 per cent within the next few years, and that new home sales had hit a near 9-year high.
This optimistic statement seemed to suggest that the Federal Reserve Bank was carefully informing the markets that an interest rate hike in September was back on the table, setting the scene for rate hikes this year, perhaps one this month, and then a second in December, after the US presidential election. Arguably, the customary warning by Fed chair, Janet Yellen, was then itemized by saying that the Fed’s penultimate decision would depend on additional US incoming data, and factors such as external data.
Clearly, September is going to be a busy month for data events: there is the meeting of the G20 in China, statements by the European Central Bank and the Bank of Japan, not to mention the first of the US presidential debates. But of Course, it was Fridays August US non-farm pay roll numbers that set the scene for what the Federal Reserve Bank might do later this month and their FOMC meeting.
“September is going to be a busy month for data events”
Certainly, any probable move by the Fed on short-term rates this month may now been dampened by the keenly anticipated US jobs report for last month, given that the consensus forecast was for a 180,000 rise, and the actual figure came in at 151,000, markedly below July’s downwardly revised 271,000 increase. However, on a more optimistic note the August figure was sufficient to keep the jobless rate steady at 4.9 per cent, but yet perhaps more awkwardly for the Fed, was the annual growth rate of average hourly earnings, which slipped to a six-month low of 2.4 per cent.
Obviously this has created a dilemma for the Fed given that many analysts believe that the August number was not strong enough to warrant for any action to be taken by the Fed this month but the likelihood of better jobs numbers and wage growth over the coming months might be enough to see them hike interest rates in December, exactly one year after the last hike. Perhaps more worrying is that the longer the Fed hold out the more likely it might be that when the tightening cycle begins it will be more aggressive than the market is currently expecting, which in turn, could lead to a period of high volatility in both bond and equity markets.
“Many Fed Committee members and financial market watchers think it’s time for the Fed to begin to normalise its interest rate policy very carefully so as not to spook the financial markets”
Understandably, there is risk attached to the Federal Reserve Bank standing on the sidelines for too long, given the current longevity of this loose monetary policy stance that they have taken. Indeed, for many Fed Committee members and financial market watchers think it’s time for the Fed to begin to normalise its interest rate policy very carefully so as not to spook the financial markets and create either a bond or equity market tantrum. Certainly, since last December the markets have expected the Fed to react to the better economic conditions given that many expect the US to experience a recession in the next 3 years or so and therefore interest rates need to be higher to accommodate that possibility.
In respect to the global picture, both equity and bond markets continue to react positively to loose central bank monetary policies, clearly inflating asset prices, whilst driving many indices to new all-time highs. This illogical situation is against a backdrop of a moderating global economy, a below par corporate profits outlook, and periodic bouts of sharp volatility. Indeed, last weeks market reactions was no different, as US and European stocks hit four month highs on the assumption that the Fed will now hold back on raising interest rates in September on the back of the latest US jobs report.
Similarly, in the bond markets the sensitive two-year US Treasury note, which moves inversely to the price of the security, fell on the back of the jobs report before bouncing back. Conversely, on a much wider perspective it would appear that yields in many of the developed western bond markets have been edging up over recent weeks, perhaps indicating that the market is now sending a signal to the central bankers that negative rate policies are not the answer and that they are losing faith in central bank policies. Either way, any meaningful move back into positive yield territory will have a potential psychological impact on financial markets.
“Any meaningful move back into positive yield territory will have a potential psychological impact on financial markets”
Indeed, the legendary bond investor Bill Gross has been very vocal in recent weeks pointing out his concern over central bank policy which has led to historically low bond yields. Indeed, the probability of a painful period in the markets, once a reversal in bond yields begins to happen, is worrying, even if there is only a small increase in yields it is likely to lead to a meaningful drop in bond prices. This is clearly a time when bond investors need to be wary given the risk reward ratio that bonds now offer going forward.
Now touching upon other asset classes’ commodity prices have been gaining some momentum over recent weeks. Indeed, zinc has hit a 14-month high, jumping by 47 per cent over the year, similarly, iron ore futures in China have rallied by 31 per cent over the year, whilst steel rebar futures have gained 36 per cent. Clearly, Chinese demand tends to be a significant driver for many commodities, and the recent release of China’s official manufacturing PMI figure, which has surprisingly risen to 50.4 in August, and a 22-month high, is perhaps signifying that the concerns over China’s slowdown might have been overdone in recent months.
Admittedly, in the case of steel prices, the recent shutdown by many of the steel mills by the Chinese government could be instrumental in the price rise, especially as we enter the months of September and October, traditionally a period of higher demand. Never-the-less, it will be interesting to hear what the Chinese authorities say about their economy at this week’s G20 meeting in China.
Similarly, the UK’s Prime Minister, Theresa May, on her first visit to China is likely to be interrogated by the other G20 members, and the media, about Britain’s stance on Brexit and the probable timing for the invoking of Article 50 and Britain’s exit from the European Union. In fact, the Prime Minister has already stated that invoking Article 50 will not happen this year, and that in her opinion it is now all about getting Britain to forge ahead and be successful outside of the EU.
“The British economy does not appear to have suffered by that much, indeed, on Thursday the latest manufacturing data was a pleasant surprise”
Certainly since the European referendum vote in June the British economy does not appear to have suffered by that much, indeed, on Thursday the latest manufacturing data was a pleasant surprise which led to a rebound in sterling, and a further recovery in the FTSE 250 Index, which is deemed to be more domestically focused, similarly, the yield on the UK 10-year gilt nudged upwards to a four week high. Similarly, it would seem that the Bank of England’s decision to cut interest rates by 0.25 basis points last month, and announce a further bond buying scheme, has partly cushioned the drag on the UK economy since the outcome of the Brexit vote.
Whilst we still expect monetary policy support to continue, it is also likely that the new Chancellor, Philip Hammond, will announce some new measures within the autumn budget statement but he may have very little wriggle room in respect to balancing the books. Clearly, the collapse in sterling has been a welcomed support for sectors such as retail, tourism and leisure given the increase in tourism to the UK over the summer months.
Finally, the month of August was fairly rewarding for those investors that embraced risk, but less so for those that were risk adverse. Indeed, we continued to see money inflows into emerging market debt and equities which was rewarded given that the global regions of Asia [ex Japan] and the EM’s delivered the best returns over the month of +4.79% and +3.89% respectively, whilst the developing markets out-performed those of the developed world.
“The month of August was fairly rewarding for those investors that embraced risk”
And in respect to the month of September, obviously, markets and investors will be focusing upon all of those important issues, and events, that I have mentioned in my previous paragraphs, however, the most important of these that will affect market sentiment the most, is likely to be the decision made by the Federal Reserve Bank on whether to tighten or remain accommodative.
Whatever the outcome the risks still seem to be skewed towards weaker growth, which in turn, is likely to lead to further central bank assistance which should favour equities over bonds.
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 .