August is the holiday month and with many key decision makers, in particular, the politicians, away from their desks, it’s normal for things to be a little quieter. Theresa May, for example, took a three-week break for some walking in the Swiss Alps, presumably with the ‘Sound of Music’ on her iPod and ‘Climb Every Mountain’ on repeat. It would come as no surprise if we did not see a great deal happening in markets, but this August saw some pleasing gains.
Short term interest rates remain subdued in the developed markets, although the expectation is that they will be moving up in the US. Inflation is not heading up above central bank targets but it is likely to edge higher, especially noting some of the short term factors we mention below. In fact, short dated US bonds contain a small negative term premium reflecting low expectations of inflation and continued demand for top quality, low-risk assets. Longer term, the outlook for bond returns is for a small premium above cash yields. Annual return estimates for UK Gilts, for example, over the next 10 years hover around 1%pa. Mark Carney may complete his second term at the Bank of England, without ever raising rates.
The annual meeting of global central banks took place in the mountains of Wyoming. Neither Fed Chair Yellen nor Mario Draghi, head of the European Central Bank, gave a great deal away. Yellen’s contribution was essentially a piece of self-congratulation for the audience to enjoy for its regulatory response to the Credit Crunch, and perhaps a plea to the politicians not to have those changes reversed. Draghi praised the impact of multilateral policy organisations – hardly surprising if you see things from an EU perspective. He said nothing about the recent strength of the Euro, perhaps implying that he is happy to see the currency rise further.
Is it good luck or bad luck that comes in three’s? Anyway, Donald Trump had to handle the triple threat in August of a deadly race riot, and the ensuing PR disaster, a significantly raised level of threat from North Korea and the chaos of a hurricane.
The upshot from events in Charlottesville was that Trump lost the spine from his caucus of senior business advisers, led out of the White House by the black CEO of Merck, Kenneth Frazier. Trump followed him out with a pointed tweet about his ‘overpriced drugs’ but the real damage was done to the President’s standing.
The more we look at geopolitical events, like the North Korean standoff, the less we seem to worry. We were reminded by Deloitte that it took only a little over a month for the Dow Jones to recover its level after Pearl Harbour and similarly the market shrugged off the provocation of a missile over Japan as a side issue. The history of this situation is that the US has bought off North Korea in the past with cash and one assumes that it rather wants that arrangement to continue.
Storm Harvey, by contrast, looks like it has had an impact on the US mainland and economy that Kim Jung-un could only imagine. Estimates circulate of the damage costing between $30bn and $100bn (0.2%-0.5% of American GDP). This is smaller than some other natural disasters of recent years with Katrina costing $110bn (0.8% of GDP at that time), and the 2011 Japan earthquake $210bn (3.5%). As a clear national disaster, Congress will be less likely to prove awkward in increasing the federal debt ceiling in the Autumn and this will be a positive.
Where Harvey will have the greatest impact is in its disruption of gasoline supplies, and the hit to US refining capacity has seen petrol prices jump by up to 25% in the wholesale markets. Retail prices are still less than 50p a litre, in our terms, but the effect is estimated to be going to add as much as 0.3% to inflation once the downstream impact is felt at the pumps, in September. Unlike, George W. Bush, Donald Trump seems to have handled himself well in reaction to the disaster but his approval rating has hit a new low. Foreign adventure now seems to be tempting the 45th President, as much as it did the 43rd.
Over the summer break, it looks as if the Cabinet has been able to come to some kind of working arrangement between the Chancellor, Philip Hammond and David Davies, the chief Brexit negotiator. These two are philosophically on different sides of the argument around Brexit but look like they will collaborate on a softer, transitional approach to the disengagement. That would be a big positive if there was some hope things were moving a little faster in the direction of a successful outcome. The return of MPs to Parliament will see if Theresa May’s authority remains intact. A key indicator for politicians, the house price index softened in August, with the likely loss of dynamism in London pulling back expectations.
The upswing in sentiment towards Europe continues, and the Euro continues to strengthen. Politics is taking centre stage with Macron’s attempts to reform the sclerotic French labour market and Angela Merkel looking for another term in the German elections on 24 September. After 12 years at the helm, she has huge international prestige and can point to a robust economy and full employment. The role of German Chancellor is taken by the leader with a majority of support in the Bundestag, so it is not a separate election of a single leader as in the US and France. Her performance in the weekend’s election debate was a success.
Asia, Pacific and Japan
The EU’s trade deal with Japan stands as a symbol of what the UK Prime Minister would have liked to bring back from her visit, and she seems to have succeeded. The EU agreement, struck in July, envisages an end to tariffs on key manufactured goods, in particular, car parts, and closer alignment on pharmaceutical regulation, within commitments to more open trade in services. It comes into force in 2019, a key year for Brexit, and it looks as if Japan will allow a ‘cut and paste’ equivalent to the UK thereafter. But, there were words of caution too. Japanese business does not like worrying about the unexpected to disturb its planning, and the implication is they badly want transparency on what the outcome of our EU negotiations will be, as soon as possible.
China is hosting the 9th annual summit of BRICS nations in Xiamen this week, with a little harmony breaking out between the hosts and India, their immediate rival among the up and coming nations. The two sides have been in a stand off in the Himalayas, but have drawn back from anything appearing like confrontation. China has sought to enlarge the membership of the BRICs group at the event by inviting five new delegations including representatives from Mexico and Thailand. The agenda will focus on the promotion of co-operation in trade and financial services, and China’s communication and transport initiative, with its ambitious plan for heavy duty rail, road and shipping infrastructure binding China into the rest of the world. Their rail service from Yiwu in the east of the country 7,500 miles all the way to London began operation in January.
Chinese foreign exchange reserves
On monetary matters, Chinese foreign exchange reserves rose by $24bn in August, making it six months of uninterrupted increase and bringing their total holdings of overseas currency back above $3trn. This is reassuring markets which were concerned capital might be leaving, potentially hitting global growth. A sharp depreciation in the Chinese currency might be expected to cause a spike in deflationary pressure around the globe, as their goods would be suddenly so much cheaper. The signs are reassuring that the People’s Bank of China has answered questions about its ability to maintain monetary stability at home.
The above article was first published by Parmenion on 7th September 2017
* All performance data quoted in this article is derived from FE Analytics