Please see below, Brewin Dolphin’s ‘Markets in a Minute’ update which provides a brief analysis of the key factors currently affecting global investment markets. Received last night – 17/12/2024
Although there were some hiccups in the U.S. stock rally last week, it broadly continued its strong recovery since the U.S. election. Leading the pack were the so-called Magnificent Seven, as investors raised hopes that artificial intelligence (AI) would yield more rewards and efficiency gains for technology software and cloud companies. Four of the Magnificent Seven’s stocks, Amazon, Alphabet, Meta, and Tesla, all hit record highs.
Aside from the ferocious U.S. stock rally, one piece of statistical evidence shows that animal spirt has been ignited after Trump’s victory. Last week, according to the U.S. NFIB’s Small Business Optimism Index, the outlook for U.S. business conditions saw the biggest monthly increase on record, driven by post-election exuberance and optimism on pro-growth policy shifts. Interestingly, we saw the second-largest increase of the same index after Trump’s 2016 victory. Perhaps U.S. President-elect Donald Trump can trademark the term ‘animal spirit’?
However, European stocks only made small gains, as the markets await French President Emmanuel Macron’s decision on a new prime minister. Investors are also contemplating the development of China’s stimulus plans as there was both excitement and disappointment on the stimulus guidance.
China’s ‘moderately loose’ monetary policy for 2025
At the beginning of last week, the Chinese authorities announced that their monetary policy stance will be ‘moderately loose’ in 2025. This is a significant change in guidance because for the past 14 years, the official guidance on monetary policy has been ‘prudent’. At the same time, the authorities pledged they would be ‘more proactive’ on fiscal policy and would stabilise the property and stock markets.
However, the lack of detail has remained a big issue. Investors were awaiting more concrete steps on how to boost consumer spending from the Central Economic Work Conference. One reason for this lack of detail could be because the Chinese authorities are saving some ammunition to deal with trade tariffs, as there is so much uncertainty on what Trump will do.
The other explanation is that while China’s leadership understands the need to shift policy to support consumption, it may not be able to decide on exactly how to design the right policy mix. Or it could be that the government is being ‘data-dependent’ because it feels the need to be patient so that the previous stimulus can show its impact. The bottom line is, there is clear guidance to stimulate the economy and more will come in 2025.
The U.S dollar versus the Chinese yuan
If the Chinese economy continues to struggle and faces more headwinds due to trade tariffs, China will look to deploy all possible means to stimulate the economy. This would be via monetary, fiscal and exchange rate policies.
Due to expectations of lower interest rates and worse fundamentals relative to the U.S., the Chinese yuan has been on a broad depreciation trend. Last week, there was speculation that China will devalue the yuan versus the U.S. dollar in 2025, potentially to 7.5. This should come as no surprise as it’s one of the ways to counteract the impact of trade tariffs by allowing for a more competitive exchange rate.
History has proven to be a good guide too. We’ve seen the Chinese yuan depreciate as much as 14% versus the U.S. dollar over a two-year period since the U.S./China trade war officially began in 2018. In 2015, China took the market by surprise by devaluing the yuan to support growth. This resulted in a messy situation and provided a clear lesson to manage such devaluation more carefully.
The expectation of the U.S. dollar to Chinese yuan exchange rate being 7.5 suggests there’ll be around a 3% depreciation from current levels, which isn’t much. It’s unlikely to offset the impact of tariffs that could be as much as 60%, but every little helps. China will remain cautious in managing the pace and extent of yuan depreciation, but given tariff threats and divergence in economic fundamentals, it’s unavoidable. For instance, last week, the 10-year Chinese government bond yields plunged to a record low of below 1.8%.
The problem is if the Chinese yuan depreciates, it can result in a race to the bottom for other Asian and emerging market (EM) currencies. This is particularly relevant as the euro is depreciating too, which is an anchor for European EM currencies. In an environment where there’s a stronger U.S. dollar, heightened volatility and headwinds for EM assets are more likely.
U.S. inflation changes
The U.S. saw two pieces of inflation data that suggest an improvement in headline inflation for consumer prices and wholesale prices. The first was on U.S. consumer prices index inflation, both headline and core measures came in exactly as expected across yearly and monthly measures. While headline inflation has picked up a little, investors are unlikely to be concerned amid a broadly disinflationary trend.
Meanwhile, producer price inflation has picked up more than expected. Producer prices are wholesale prices that have the potential to filter through to end-consumer prices, so the recent acceleration trend should be watched.
It’s generally expected that a stronger U.S. dollar would help keep imported inflation in check.
How will Trump’s policies impact inflation?
Trump’s policies, including tax cuts and tariffs, will likely impact inflation going forward. The consensus is that his policies are inflationary, in the near-term at least. Because inflation could be harder to tame in a strong economic environment, investors have been trimming expectations for rate cuts next year.
With the Federal Reserve fixated on cutting interest rates again in December, last week’s data is unlikely to change that. However, markets are broadly expecting a somewhat ‘hawkish cut’, meaning the guidance for monetary policy could turn more cautious despite delivering another rate cut this week.
What’s happening in Europe?
In the Eurozone, the European Central Bank (ECB) cut key policy rates as expected, but market impact has been muted as the decision was fully priced in. The good news is that the ECB continues to see inflation progressing towards its target and stabilising, evidenced by it lowering its 2024 and 2025 inflation forecasts. This is a relief, as there was concern that the sharp depreciation in the euro could push inflation a little higher than previously pencilled in.
On the negative side, gross domestic product (GDP) growth forecasts were revised down over the same period, while 2027 growth is projected to be muted too. The combination of weaker growth and disinflation allows the ECB to drop the ‘restrictive’ policy guidance. In 2025, the ECB is likely to ease policy at a faster pace compared to the U.S. and the UK due to its struggling economy and headwinds from potential tariffs.
While in the UK…
At the end of last week we saw UK gross domestic product (GDP) data for October, which contracted for two straight months. The three output measures of GDP – services, manufacturing, and construction – all detracted from growth in October.
This data isn’t great for the current government because since Labour took office, UK GDP has only expanded in one out of four months. This contrasts with the strong growth we saw in the first half of 2024, although we were rebounding from a technical recession in the second half of 2023.
Just as the U.S. displays its ‘animal spirit,’ UK businesses have turned more pessimistic on the outlook after the Autumn Budget. This is evidenced in the Bank of England Decision Maker Panel survey, which shows that businesses think hiring and revenue growth will slow, while inflation will rise.
Last week, the London Stock Exchange suffered another blow as construction equipment rental heavyweight Ashtead said it will move its primary listing to the U.S. Although the U.S. is a ‘natural long-term listing venue’ for Ashtead as it derives almost all of its operating profit from the U.S., this is another concern for the reputation and attractiveness of the UK capital markets.
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Alex Kitteringham
18th December 2024