Market Bulletin (07/11/2017)
Easing off
The last time the Bank of England raised interest rates, it was quickly overtaken by events. On 5 July 2007, the Monetary Policy Committee raised rates by a quarter of a percentage point to 5.75%, and employed restrained language in its assessment of the economic forces at large.
Such heights are unthinkable today. Since 2009, the base rate has sat below 2%. Perhaps more importantly, the Bank launched an unprecedented era of quantitative easing to stimulate the economy.
Last week, it technically turned the monetary corner, raising interest rates for the first time in a decade. “The time has come to ease our foot off the accelerator,” said Mark Carney, the Bank’s governor. “That will help to bring inflation back to its 2% target while still supporting jobs and growth.”
In reality, however, the UK is in strange economic territory. As Mark Carney remarked, unemployment sits at a 42-year low. Yet while the US and eurozone are growing at a strong clip, economic growth in the UK economy has been sluggish, wage growth is far below inflation and productivity growth has been essentially flat for a decade. GDP has risen only 10.9% in that time and the FTSE 100 is just 12.9% higher, but 10-year gilt yields are 4.1 % lower. No wonder the governor said these are “exceptional” times.
Unfortunately for savers, the “exceptional” environment means the latest rise in interest rates won’t offer them much solace – and not just because plenty of banks aren’t passing it on. Even if they were, inflation of 3% and interest rates of 0.5% is a costly combination for cash holdings. Carney said that he only expects rates to rise very gradually; a mere two rate rises over the next two years.
Moreover, investors responded as though rates had been cut, not raised, pushing down sterling and pushing up stocks – the FTSE 100 ended the week on a closing high, up 0.74%. In reality, markets were responding not to the rate rise itself, which had been well-telegraphed, but to the BoE’s relatively gloomy economic outlook.
“Uncertainties associated with Brexit are weighing on domestic activity, which has slowed even as global growth has risen significantly,” the Bank reported. “And Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been increasingly evident in recent years in the rate at which the economy can grow without generating inflationary pressures.”
All the same, there were several positive economic indicators published over the course of the week. Manufacturing output rose significantly, thanks to new orders, while job growth in the sector struck a three-year high. Foreign investment in the UK struck a new high in 2016, according to Office for National Statistics figures published midweek, as the country attracted £119.6 billion of new investment – although more than 80% of the figure was generated by foreign acquisitions of two major UK-listed companies, Arm Holdings and SABMiller. UK services also showed signs of healthy momentum, as a leading indicator pushed still higher, although job creation in the sector struck a seven-month low.
Corporate groundswell
There were several strong sets of corporate results, among them those of HSBC. Pre-tax profits at the UK-listed bank shot up by a stunning 448% in the third quarter on a boom in Asia trade and cost-cutting measures. Banks had been among the laggards on markets during the recovery after the financial crisis, but have enjoyed strong results in recent quarters – and their share prices have risen in response. BT, on the other hand, was a significant disappointment, as its Global Services unit suffered a 39% fall in earnings due in part to alleged fraud in Italy.
There were corporate tailwinds on both sides of the Atlantic. The Eurofirst 300 ended up 0.74% as a number of major sectors enjoyed positive earnings seasons – Société Générale and Air France-KLM were among the best performers. In the US, Facebook enjoyed (another) heady set of earnings results, posting a revenue increase of 47% – its shares have risen 60% this year alone. Google and Apple also performed strongly, but it was not merely technology that buoyed markets – Kellogg and Mondelez were among the major names to post strong results. US stocks were hit by a disappointing non-farms payroll report, which showed just 261,000 jobs added in October – around 50,000 below expectations – although the jobless rate fell slightly. The S&P 500 ended the week up just 0.13%.
Markets were also sensitive to the Republicans’ announcement of agreement over the new tax-cuts package. Under the proposals, corporate tax would be cut from 35% to 20% and income tax would drop. Although the U.S. Chamber of Commerce warned that “a lot of work remains to be done” for the package to work well, there was some relief that the likely impact on the deficit was smaller than expected. Thus, it would increase by $1.5 trillion over ten years, still well within the limits that would enable Republicans to pass it through Congress without Democrat support. Part of the budgetary balancing act resulted in less favourable tax rules for certain individuals – local tax will no longer be deductible against state taxes, and neither (for future homebuyers) will mortgage interest.
If the Bank of England’s rate decision looked somewhat unexciting by historical standards, the Fed’s was still less so. The Federal Open Market Committee (FOMC) chose to leave rates unchanged, but reported that solid economic growth and an improving labour market meant a further rise was on track for December. Although inflation has risen to 2.2% in the US, questions remain over the longer-term outlook for inflation across several Western economies, given structural trends, implying that interest rates may not rise rapidly any time soon.
“The central banks do not actually know whether lagging inflation is [due to] something structural,” said Hamish Douglass of Magellan Asset Management. “My view is that [lagging inflation] is driven by ageing demographics in the Western world and, even more important, by the impact of technology on wages inflation into the future. On a ten-year view, those will become even more important. We are going into a higher rates environment, but it won’t be as high as in the past – unless inflation returns.”
Despite the lack of movement, the Fed won plenty of attention as Donald Trump finally announced his choice to chair the central bank for its next term. Janet Yellen’s replacement will be Jay Powell, the first non-academic to hold the post since 1978. Powell was appointed to the FOMC by President Obama and is not expected to rock the boat – he has voted with Yellen in the past, despite the growing tendency of FOMC members to vote as individuals under the last two chairs. His two predecessors have had to deal with the global financial crisis and its immediate aftermath. With equities much higher and bond yields subdued, he will face a somewhat different environment.
Meanwhile, investor interest in Japan continued to grow last week, as Japanese stocks enjoyed their biggest inflows in seven weeks, according to Bank of America Merrill Lynch figures. The Nikkei 225 finished the week up 2.4%.
Magellan is a fund manager for St. James’s Place
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