Global Markets to 08 October 2018
- Global equity markets experience a difficult week led by falls on Wall Street.
- The US benchmark 10-year Treasury bond yield hits a new seven-year high.
- On the FX markets, the dollar loses some of its shine as employment figures are better than expected.
- Given recent data, the Federal Reserve Bank is likely to hike rates again in December.
- The price of oil continues to rise and is now close to a four-year peak.
- With rising US bond yields will come continued short-term pressure on global equities.
Global equity markets are beginning to suffer from a sentiment change as the US benchmark 10-year Treasury bond yield jumps to a seven-year high, while the US unemployment rate falls to its lowest level in 49 years. This has indubitably affected daily market investment sentiment. However, it is perhaps more important to focus on any changes in monetary policy being implemented by the Federal Reserve Bank towards future guidance on tightening.
Another set of better-than-expected employment figures in the US combined with the potential for rising wage inflation will obviously increase the likelihood of a further interest rate hike in December; but has the Fed become more hawkish? Recent comments made by Fed Chair Jerome Powell do not give that impression. According to Powell, “[…] we are gradually moving to a place where [interest rates] will be neutral […], but we are a long way from neutral at this point”.
The Federal Reserve Bank is likely to remain pragmatic and will raise interest rates very slowly. This will allow financial instruments – such as equity and bond markets – to cautiously adjust back to a world in which interest rates normalise. Furthermore, while US economic growth has been exceptional in recent times, it is likely to moderate henceforth, while inflation remains relatively subdued. The Fed can, therefore, afford to remain relatively calm; for the time being, at least.
On the political front, President Donald Trump described Canada’s eleventh-hour decision to join the US and Mexico in a revamped trade accord as “a great deal for all three countries […] and a historic transaction!”. The US-Canada agreement follows weeks of tension between both countries’ governing bodies and their respective negotiating teams and was greeted extremely positively by the markets. The US has also agreed to begin bilateral trade talks with Japan. This has also been heralded as a step forward.
Unfortunately, the backdrop is still characterised by a number of black swan events. These include the escalation of trade war tensions between the US and China, rising crude oil prices and fears to do with Brexit and the Eurozone, all of which could quickly alter the investment landscape. Currently, however, a pick-up in short-term volatility is the only thing with which the markets have to content. But it is well known that October is renowned for being a month of impulsiveness: a sudden flash crash event should not be ruled out.
Financial markets are therefore likely to be extremely carefully scrutinised over the coming weeks for any tangible deterioration – perhaps none more so than the US 10-year Treasury bond yield and the S&P 500 index, since they are the largest bond and equity markets in the world and have the greatest influence on market and investor sentiment.
Global growth is strongly influenced by the US economy, and this current bullish economic cycle is now in its ninth year – the second longest expansion since records began in 1854. Fiscal policy has become more conducive to faster economic activity and the large tax cuts announced by the Trump Administration have certainly propelled US corporations into a frenzy of domestic investment. This has led to a huge rise in corporate profitability, lower levels of unemployment and Wall Street climbing to all-time highs.
Regrettably, the investment landscape in the world’s other regions – such as China and emerging markets – has been deteriorating, registering peak-to-trough falls in excess of 20%. A toxic cocktail of higher US interest rates, a stronger US dollar and localised political events has constituted a strong headwind for many of these regions and domestic markets. At the same time, some of these more exciting developing markets are now beginning to look cheap… and possibly investable again.
Focusing on the UK, the Brexit predicament continues. Prime Minister May has convened crisis talks at Number 10, the European Union has offered the UK a supercharged free trade Brexit deal and Scotland’s First Minister Nicola Sturgeon is now calling for a second Brexit referendum. It looks as though for the foreseeable future, the UK will continue to see its economy and the health of its stock market ebb and flow in time with the waxing and waning probabilities of a hard Brexit, a soft Brexit… or even no Brexit at all.
As far as sterling is concerned, it will remain vulnerable to further downward pressure until we have a clearer picture of the outcome. Similarly, sterling-denominated assets are being forfeited in favour of overseas assets and a hedge against a bad Brexit. This could leave the UK stock market looking rather inexpensive if a constructive deal between the UK government and the European Union were to be finalised.
To conclude, equities are expected to continue to outperform bonds. But that scenario is not without some risks. First of all, we could see a sharp pick-up in inflation. That could force the central banks to tighten policy far more aggressively than anticipated. Secondly, trade protectionism could lead to a currency war and to devaluations, which could stifle global growth and affect corporate profitability.
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment 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.
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