Market Updates

This week, we got further support for the status quo. Positive economic data, including a higher than expected GDP data was coupled with a decision from the central bank to leave things alone and let everything carry on as it is. Unfortunately, our political leaders don’t have the same appreciation for inactivity. Boris Johnson especially appears to believe that he gets paid by the word and treated us to what appears to be the opening salvo in his battle for the Tory leadership. While even Brutus would have raised an eyebrow at the amount of plotting going on in the Tory party, it does at least appear that they are giving up on trying to control Brexit and have instead focused on grasping the leavers of power afterwards.

Elsewhere, Hurricane Florence has made landfall in the Carolinas and has already begun to have a serious impact. A competent response to the storm will be critical for Donald Trump and the republicans if they are to retain any sense of credibility as a party of Government and to survive Novembers mid-terms elections. George W. Bush’s approval ratings never recovered from his botched handling of hurricane Katrina.

UK: Economic Growth Picks up over the summer
This week, the Office for National Statistics reported GDP results between the months of May to July. GDP grew by 0.6% during this period, mainly carried by the service sector which helped fuel the quickest economic growth for the UK this year. The cause of the growth was linked to positive results from the retail industry with factors such as the hot weather, England’s extended run in the world cup and the royal wedding all helping to drive sales this summer. In addition, the month-on-month output for the construction industry was also up 0.5% in the month of July.

Over the last 5 years, GDP has experienced quarterly fluctuations with slight increases in growth along with some periods of shrinkage. In the last two years the results have tended to fall between 0.2% to 0.4%. Overall, year-on-year GDP growth continues to be stable hovering above 0.5% with notable spikes recorded in the third quarters of 2012 and 2013.

Global: Lira Rallies after central bank's announcement
Turkey’s central bank decided to raise interest rates yesterday. The one-week repo rate was increased to 24%. The lira, one of the world’s worst performing currencies this year increased by 4.6% against the dollar shortly after the announcement. The move appeared to directly contradict president Erdogan’s earlier calls to reduce the interest rate in order to lower borrowing costs. Erdogan also proposed to outlaw the use of foreign currencies within the Turkish property market in a bid to help the flagging lira.

Meanwhile, the two biggest economies continued their standoff this week. President Trump recently applied additional duties on $50 billion of Chinese imports and this week, the White House are reviewing applying further tariffs to $200 billion worth of products. However, tensions look to be thawing as corn and soybean futures fell slightly. The prices for both commodities were propped up by supply concerns due to the Chinese government’s move to apply higher tariffs on a selection of US agricultural imports earlier this year.

Eurozone: European Central Bank Holds Interest Rates
The European Central Bank (ECB) announced net asset purchases to be cut back by EUR 15bn along with plans to end bond purchases by the end of this year. In addition, the ECB also announced that it will look to slightly cut its growth target for the periods of 2018 and 2019 along with keeping interest rates unchanged for the Eurozone. However, the council remains confident that it will reach its inflation target even with the cutback. ECB president Draghi, linked the downward revision to weaker foreign demand.

Elsewhere, political risks remain within the Eurozone. Sweden’s latest election ended in a deadlock. The centre-right bloc held 40.2% of the votes while the centre-left took 40.6% of the vote. The votes made by Swedes abroad are also expected to be counted this week but 99% of the votes have already been accounted for. Sweden faces a period of political uncertainty after both main parliamentary blocs fell short of the majority required. The prime minister confirmed that he would not be resigning because of the election and stressed the need for cross-party cooperation so that a new government can be formed.
Author: FE Analytics
Today’s decision by the Bank of England’s Monetary Policy Committee to raise the benchmark interest rate by 0.25 percentage points has had little immediate impact as the decision was widely anticipated. The probability of an interest rate hike had moved to 90 per cent over the summer.

Bond markets had been waiting patiently for this move ever since May, when the Bank of England was poised to raise interest rates but decided to hold off at the last moment after a slew of disappointing data. During an April interview with the BBC, Carney reset the expectations for gilt investors, as he was “conscious that there are other meetings over the course of this year.”

Portfolio Manager’s View
Early signs are positive for the FE Invest model portfolios, as Gilts have actually rallied on the news. With the rate hike itself already priced in, much of the focus has been on the bank’s long-term expectations, which matter more to long term bonds than the short-term rate hike.

As has been the pattern here and in the US with previous hikes, the move has been accompanied by a deterioration in the long-term outlook, with analysts becoming more negative on future growth based on today’s move. It is a phenomenon called yield curve flattening and has had a positive effect on the gilt funds in the portfolios. The sentiment has also weakened sterling which will boost the portfolios’ international holdings as well.

Analyst’s View
Recent economic data suggests that the UK economy is still expanding (albeit at a slower pace) and that inflation probably peaked in the first quarter of 2018, as the UK economy has recovered from the first quarter blip. This has proved to be enough to justify this interest rate hike and bond investors will now get more clarity about the future path of interest rates.

Prior to this announcement, expectations of the second rate hike since 2007 has created volatility over the short end of the curve but had barely affected the long part. There is little in recent data that would warrant significant revisions to the BoE’s UK long term growth forecasts (at least beyond the end of the Brexit negotiation). Mr Carney has made it clear that the BoE does not intend to start publishing official forecasts on the future trajectory of rates. However, as suspected it has published, for the first time, its estimate of the “neutral rate of interest”, the rate at which the central bank believes the UK could grow at a sustainable rate with the economy at full employment. In the inflation report, they have confirmed that “any rises in Bank Rate are expected to be limited, and interest rates are likely to need to remain low by historical standards for some time to come”.

With little sign of improved economic growth or sudden rise of inflation, gilt investors may make the case that yields won’t rise much from their current levels despite today’s interest rate rise. With still little clarity around the Brexit negotiation and possible economic disappointments to come, we believe it would be premature to completely disinvest from this asset class.
Author: FE Analytics