Half Term Report
The table above is a snapshot of the main global markets with a UK slant. Overall , two stories have dominated markets over the last six months, which I have endeavoured to cover in my various notes starting with ‘Sound and fury signifying…something?’ (January 10th) and continuing through to ‘Apart from the pandemic’ (June 11th). Needless to say, neither story is straightforward and both have many more twists to come in the next six months.
COVID: better to arrive than travel
It took US equity investors all of 6 weeks last year between mid-February and early April to decide that both business and the wider economy were fit and well, even if hundreds of thousands of people were falling ill and worse. What investors deemed would matter was the speed and scale of the economic recovery and 15 months later things look like going rather better than expected. The first to ‘arrive’ in terms of moving ahead of GDP levels in Q4 2019 have been the US, Vietnam, Taiwan and South Korea. Not quite there but going well, are the Euro Area ,Canada and the UK although this is not reflected fully in the latest headline Q1 GDP numbers. Singapore, Thailand, Malaysia, Indonesia, Brazil Mexico and Japan are still struggling to limit the economic damage from the pandemic while India and now Australia are facing major challenges. China, which has managed to generate growth throughout the pandemic, has moved on to trying deliberately to restrain bank lending together with property and commodity prices, as always in the cause of stability.
The relative progress between the different economies in recovering from COVID is largely reflected in the their respective equity prices. US stocks have recorded their best first half performance since the happy days of 1998 but even then were not able to match the gains in Vietnam and Taiwan. Somewhat surprising has been the outperformance of French stocks, which has led prices higher elsewhere in the Euro Area while UK shares remain unfavoured in comparison. Indonesian and Malaysian markets actually ended the first half lower while even they, along with all the others are flattered by comparisons with the levels of 12 months ago.
The pandemic’s Impact on FX rates has been complicated in June by the Fed story (see below) but the top performing major currency was the Canadian dollar, followed by the US dollar and pound and the worst were the Australian dollar and the yen. As the other side of by far the largest trade, the euro has had a bumpy ride vs. the dollar while losing ground to the pound. The pandemic continues to hit hard the rupiah, ringgit and baht but the real has bounced back after 3 successive official rate hikes.
Bond yields were always likely to rise once investors finally concluded last November that mass vaccination programmes would be rolled out but this has only slowed rather than stopped the scramble into High Yielders. The main action in sovereign bonds took place in the first 3 months with yields sharply higher for both those economies coping better with the pandemic (implying official rate hikes sooner rather than later) and those that have been struggling to cope (implying more public borrowing and spending with the biggest hits were to Latin American bonds). There was some relief for US Treasuries and gilts in Q2 but not for Euro Area bonds (only 10-year bunds and DSLs still have significantly negative yields) or the more embattled Emerging Market borrowers. Meanwhile, Turkey continues to have problems of its own with its bonds and the Lira. Looming over all fixed interest yields are ongoing guesses over central bank responses to the current spurt in inflation around the globe.
Fed rate hikes: the why is more important than the when and how much
The last six months have witnessed much agonising within and between central bankers as to the limits of monetary policy and what should be done next. This has provoked a veritable tumult of commentators, most of whom are highly critical and seemingly loathe to accept that whatever new actions are taken they have ‘to start from here’. As always, the key actor and chief villain is the incumbent Fed Chair, who is currently deemed by many critics to be worrying about the wrong things (lack of jobs for younger adults, unskilled workers and those living in deprived parts of the country) and not enough about inflation.
Nobody, including Mr Powell himself, actually wants official rates to be raised this year or even next but he is damned if he does and damned if he doesn’t. In mid- June the gathering tumult boiled over into a market tantrum over the likelihood that the Fed would hike rates to stamp on inflation and undermine the post-pandemic recovery. The catalyst was the latest infamous ‘dot plot’ in which the members of the FOMC forecast their own future decisions, which in the materials released on 16th June included two hikes in 2023. Despite, Mr Powell soothing words, equities and bonds were hit while the dollar picked up new steam.
The tumult has since become less agitated but the debate goes on in the expectation that the Fed will indeed hike sooner than the dot plot suggests. If the hike is in response to a strong non-inflationary recovery, then that would be deemed bad for US assets and the dollar on the basis that stock prices cannot really go much higher or bond yields lower and investors will look elsewhere in the world. If the hike is in response to inflation’s turning out steeper and less ‘transitory’ then stocks would retreat, bond yields rise and the dollar would be a suitable haven. The situation is much more straightforward for other central banks: rate hikes almost always dampen asset prices and support the currency.
Second half
The somewhat perverse debate over the Fed’s motivation is unlikely to be resolved soon, although Mr Powell may reveal more at the annual central bank Symposium in Jackson Hole in late August. Meanwhile, none of the Fed or other major central banks is likely to hike before the end of 2021 even if there is a succession of fancy headline consumer inflation numbers. It may be helpful to note two apparent definitional changes that are relevant to the debate. The ‘reflation trade’ seems to mean betting on healthy non-inflationary growth while ‘growth stocks’ seems to mean stocks of companies that will grow irrespective of the economic cycle and perhaps the actions of the central banks.
Should the Fed debate be resolved one way or the other, markets are likely to react in the ways described above. US equities continue to set new records and are, accordingly, vulnerable to shifts in sentiment. However, the Q2 earnings parade is likely to confirm that this a bumper year for US companies. Encouraging signals from Euro Area and UK companies should provide support for their share prices. Woe betide, however, any company that falls short of expectations.
US Treasury are unlikely to fall much further even as the Fed holds off and, indeed, 10-year and 30-year yields around 2.5% and 3% respectively could encourage investors to pile in. There should be no shortage of supply as the Biden Administration presses on with its ambitious investment plans. Gilt yields are likely to follow suit, although the UK Government seems divided on its approach to borrowing and spending. The bills are still coming in for the pandemic and the consequences of Brexit are still largely unquantified but the new harmonious tone to EU-UK relations suggests that minds are being concentrated on both sides. Internally, the EU itself seems to be taking one step forward and then another one back. The pandemic recovery plans are going well enough but the rows with the Eastern Europeans are looking increasingly existential.
Most of the developing economies have their hands full in containing COVID and any large-scale failures would inevitably adversely affect the advanced economies. It seems clear that most governments will only reimpose restrictions as a last resort even if hospitalisation and death rates keep going higher. Even if COVID is ‘sorted’ in the next 12 months it should be remembered that things were not going so well before it struck.
Disclaimer: This report is compiled from sources the author believes to have been reliable but it may not be complete or accurate on any particular subject. All opinions, estimates, and analyses are or were those of the author at the date of issue and are subject to change without notice. Accordingly, the author makes no representation or warranty on any subject discussed in the report; nor does he accept responsibility or liability for any claim, loss, damage, expense or cost arising from reliance upon its contents.