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Competing policy measures leave markets fearful – Tatton Monday Digest

Please find below, an update on markets received from Tatton, this morning – 17/10/2022

Outlook: Bond markets 1 – UK Government 0

It is seldom that the UK alters the course of global capital markets, particularly given our domestic stock market comprises just 3.1% of global equities and 4.1% of the global government bond market. However, over the course of October, far bigger bond markets – like that of the US and Italy – have experienced significant changes in the wake of events earlier in the day in the UK.

In our view it can all be traced back to a profound misunderstanding of the UK’s relative position in the global competition for capital at just the point when central bank’s decisive anti-inflation measures have re-introduced fragility into capital markets not seen since the 2010-2012 Eurozone crisis. To this end, the US economy has been attracting huge swathes of capital and the US dollar has motored ahead, with interest rates and bond yields rising in parallel to expanding economic activity. In particular, the sharp rise in yields on US inflation-linked bonds has been at the heart of the stresses in the global economy. With the rest of the world facing massive competition for capital, it was unwise for the UK government to make a grab for more at a point when the costs have been made almost unbearable. To blame circumstances now suggests Liz Truss et al. were unaware of the situation when devising the policies. It’s no wonder the Chancellor is now a different person. Indeed, global markets have been cheered by signs the UK is unwinding its recent pronouncements. Should it reverse the bulk of policies that capital markets balked at as fiscally irresponsible, then rates and yields may still revert to the trajectory they were on before September’s fateful fiscal event. Whether they can do so fully will largely depend on how much of the reputational trust in UK institutions lost by international investors can be regained.

From the global perspective, beyond the UK’s domestic woes, the October 2022 UK bond market crisis will be remembered as the moment when central banks around the world were forced to grapple with something they have been denying for many months. Namely that their formidable efforts in forcing the inflation genie back into the bottle have unveiled fragilities in the global financial markets that may now hamper their ability to follow through with their inflation fighting strategy. The dependencies on ultra-low interest rates they had allowed to build up since the Global Financial Crisis mean that the risk that something, somewhere, in the global financial ecosystem would break – or at least seriously buckle – has now become all too apparent.

Will UK property downturn change the investment landscape?

In the wake of Kwasi Kwarteng’s ill-received fiscal event, lenders pulled swathes of mortgage products in expectation of sharply higher interest rates from the Bank of England (BoE). The potential effects on consumers and households were well-publicised – but as well as households, damage has also been done to equity markets – particularly to property funds and house builders. Both have fared substantially worse than the broader market throughout the year, and the latest drama precipitated another swipe down. The building sector has nearly halved in value since January, while real estate investment trusts (REITs) have lost around 40%.

Clearly, these problems precede the fiscal fallout – though it undoubtedly made the situation considerably worse. Both sectors fared well throughout the pandemic, buoyed by an increase in consumer savings and property deals. But the sharp contraction of monetary policy since the beginning of the year has made conditions extremely difficult.

With the UK probably already in recession, commercial property is one of the most vulnerable sectors. This would be the case even without the supply-side inflation pressures and fiscal imprudence, since house building and purchasing are extremely cyclical. We are also seeing this stress spread to banks with large property-related loans on their balance sheets – many of which have seen their share prices come under pressure. It seems that, having (somewhat) stabilised the pension fund problem in recent weeks, property is the new site of financial and economic instability.

Unfortunately for many property companies, there is little they can do about the situation. Balance sheet management has improved vastly in recent years, and property funds have made themselves much more resilient. But with the tide turning against them, some will probably fail – barring a shock turnaround in the underlying trends. However, improved balance sheets mean many of the larger players -particularly those unrelated to danger areas like inner city office space – will be able to weather the storm. When they come out the other side, they will find a significantly cheaper market ripe for plundering.

Headaches all round after the UK’s Gilt trip

The BoE’s emergency intervention three weeks ago was vital in stopping the gilt market bleed. But last week, Governor Andrew Bailey was keen to remind everyone that what the Old Lady giveth, she can taketh away. He responded to extension requests on the BoE’s bond-buying programme by firmly telling UK pension funds “you’ve got three days left”. Before giving way to optimism over the UK government’s latest U-turn, fear spread that pension funds would once again come under extreme pressure, with volatility pushing up collateral demands and making them forced sellers once more. The downturn was not limited to the UK either: US stocks fell sharply with investors concerned about global financial contagion. Bailey’s deadline was treated as an “all-time central bank gaffe” in some quarters, and sterling dropped hard and fast immediately after his comments.

But the BoE chief is in an unenviable position. His team is tasked with taming runaway inflation while avoiding a financial crisis triggered by government action that markets deemed fiscally profligate and irresponsible. In the current environment, these goals pull in opposite directions. Exceptionally high inflation requires exceptional monetary tightening, while the threat of pension fund collapse requires liquidity injections. Setting a timeline on these injections threatens to create a cliff-edge scenario, but open-ended purchases would undermine any monetary tightening done elsewhere. The BoE line was always that bond purchases were an emergency provision and would be dialled down when the immediate threat was gone.

We have grown used to near or below-zero real yields in the last decade and a half. But with the world in a sharp supply shortage (now mainly labour and fossil fuels), it is reasonable to think yields must move higher over the long-term to re-establish the balance between supply and demand. Currently, RPI-linked ten-year gilts yield 0.75% (above retail inflation). Runaway inflation necessitates some compression of activity from the BoE, meaning these real yield levels look justified. In fact, these yields arguably look attractive to global investors. That might seem bizarre, given BoE intervention seems to be the only thing keeping gilt markets intact. But the sharp sell-off had more to do with pension fund ‘fire sales’ because of a structural weak link in UK pension regulation, rather than underlying fundamentals.

The recent mayhem has caused many commentators to liken the UK to an emerging market, with fiscal imprudence and policy divergence from its central bank. But Britain is not an emerging market – it has highly functional financial and corporate structures and a highly skilled workforce. Recent bond movements bely this, but arguably suggests there are now bargains to be had. This is not to say we expect a sharp rebound (and thereby fall back in yields) – there are far too many intractable short-term problems for that – but there could be healthy returns in the future and, for the time being, yield-based return contributions we have not seen in over a decade.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell

17th October 2022

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Brewin Dolphin: Truss Confirms Corporation Tax U-Turn

Please see the below article from Brewin Dolphin, highlighting the economic impact of the government U-turn on freezing corporation tax, and the effect this is having on markets. Received late Friday afternoon – 14/10/2022.

Prime minister Liz Truss has reversed the decision to scrap the planned rise in corporation tax. Guy Foster, our Chief Strategist, discusses the impact this could have on financial markets.

Prime minister Liz Truss has announced a second major mini-budget U-turn and the departure of chancellor Kwasi Kwarteng following weeks of market and economic turmoil.

Plans to scrap next year’s increase in corporation tax will no longer go ahead and the role of chancellor has now been filled by former health secretary Jeremy Hunt. Chris Philp is no longer chief secretary to the Treasury and has been replaced by Edward Argar, former paymaster general.

Background

Today’s statement comes after the mini-budget on 23 September resulted in a steep decline in UK government bonds (gilts) and the pound, widespread stock market volatility, and lenders pulling mortgage deals from the market. The mini-budget included a much bigger package of tax cuts than had been expected, raising concerns about a surge in government borrowing and more aggressive interest rate hikes. According to the Institute for Fiscal Studies (IFS), the tax cuts would have cost the Treasury almost £45bn a year1 , contributing towards an £80bn increase in borrowing by 2026/27.

One of the biggest measures in the mini-budget was scrapping the planned increase in corporation tax from 19% to 25%. Today’s U-turn means the increase will now go ahead in April 2023, saving the government around £18bn a year, Truss said.

The government had already announced on 3 October that it was scrapping plans to axe additional-rate income tax. Removing the 45% tax rate would have cost about £2bn a year according to the government, or £6bn a year according to IFS estimates.

How are markets reacting?

Bond and share prices rose ahead of Truss’s statement as speculation about the corporation tax U-turn mounted. There were large swings in the value of the pound as traders digested the sacking and replacement of the UK chancellor.

The market’s reaction was somewhat tempered by the fact that a tax cut U-turn had been widely anticipated. Borrowing costs have, however, fallen this week as speculation continued to mount.

Today’s stock market rally came in the context of markets which were higher globally as the news was announced. This largely reflected a strong performance on Wall Street following the latest US inflation figures. Speculation about the return of the corporation tax hike did cause some volatility among companies with particularly significant UK operations, such as banks, housebuilders and some retailers, who are now facing higher tax bills.

What is the longer-term outlook?

Speculation about the U-turn had already seen UK borrowing costs fall and the new chancellor will be aware of the need to emphasise fiscal sustainability as many of his predecessors were too. It would not be surprising to see the return of self-imposed fiscal rules, which serve as guard rails to keep policy on track, and which give investors a sense of how policy will develop. These form part of the economic orthodoxy that had been shunned by this government, despite being seen as an essential policy signal by previous governments.

The latest period of turbulence could worry investors that one benign economic strategy can quickly be replaced by another they find more alarming. However, it should also reassure them that it demonstrates how the government of the day is accountable to its party, the electorate, and the Office for Budget Responsibility. An independent Bank of England will support the financial system without interfering with policy. And these institutional protections mean that change can be forced to retain the confidence of the markets. That is not true of all countries and should enable the UK to quickly regain investors’ confidence.

This is a turbulent time for the government, and we expect further changes to be announced today by our new chancellor.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Alex Kitteringham

17th October

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Brooks Macdonald – Daily Investment Bulletin

Please see today’s Daily Investment Bulletin from Brooks Macdonald received this morning:

What has happened

Markets endured another day of extreme volatility yesterday with US equities trading at one point c. -2.5% before rallying to close over 2.5% higher on the day. The cause of the volatility was of course the CPI print although it is difficult to decipher what catalysed the late market rally other than perhaps a feeling that the CPI beat ‘could have been worse’.

UK

While the attention was firmly on the US yesterday, UK assets rallied yesterday on speculation that the Truss government could reverse some of the unfunded tax cuts announced in the ‘mini-budget.’ Sterling was a particular beneficiary of reports suggesting a U-turn on corporation tax rates may be on the cards. Adding further weight to speculation was the premature exit of Chancellor Kwarteng from the IMF conference in Washington, with sources suggesting he was returning to the UK to brief MPs on proposed changes. Yesterday saw sterling rally by over 2% against the US dollar, the largest gain since March of 2020. Gilt yields also fell as bond markets priced in reduced gilt supply from a less expansionary set of fiscal policies.

US CPI Report

There was little good news for the markets within the US CPI report with headline CPI coming in above expectations, at 0.4% month-on-month. Whilst the year-on-year measure ticked down, it fell by less than the market had hoped, now standing at 8.2%. Core CPI, the more important measure to gauge the transmission of inflation throughout the economy, rose by 0.6% month-on-month compared to expectations of 0.4%. In terms of the drivers of the inflationary pressure, these were broad-based, suggesting that the Federal Reserve will be emboldened to continue their rate hiking cycle apace. Markets have fully priced in a 75bp rate hike in November and have ratcheted up the probability of a further 75bp move in December of this year. With this repricing, Treasury yields rose yesterday, and equity markets sold off sharply before climbing into the end of the day.

What does Brooks Macdonald think

There has been much speculation over the cause of the late rally in US equities given the CPI report showed more inflationary pressures than the market had expected. With equity positioning being at extremely bearish levels coming into the data release, the simplest explanation may be that many in the market had a sense of relief that headline year-on-year continues to fall, even if it continues to remain stickier than economists had hoped.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Carl Mitchell – Dip PFS

14/10/2022

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Waverton Update – Light at the end of the tunnel

Please see the below update from the fund managers at Waverton Investment Management regarding the current market activity.

Headlines in the last few weeks have been very worrying for investors. After a bad start to the year, the new Chancellor’s ‘mini-budget’ didn’t have the desired effect and has subsequently brought the topic of financial instability back into the news. But despite, or perhaps because of, the weakness in markets, there are now some great opportunities available to investors across asset classes.

At Waverton, we are watching the economic and financial developments carefully and, as active investors who are predominantly directly invested in the underlying assets, we are well positioned to adjust our holdings as and when we see fit. We have a fundamental understanding of the risks that we have chosen to take with our investments and feel that we are well placed for the coming months and years. We have a tried and tested investment process which we have confidence in.

It is important to note that as global investors we are not overly exposed to any one regional risk, we are far less invested in the UK than many of our peers for example, and while currency moves introduce a degree of uncertainty in international investments, the falling value of sterling has actually increased the value of some of our foreign assets. We are also able to hedge currency risk if we wish, something that we have recently done in some of our funds – locking in some of the returns that we earned from the move in the value of the pound.

We are, as always, wary of any macroeconomic risks that may exist, but are not yet convinced that a recession is inevitable, at least in the US where there is still a degree of economic momentum, and, for now, conversations between Waverton’s analysts and the management teams of various companies suggests that there is a degree of resilience to corporate profits. Valuation is one (very important) aspect of our equity investment process, and the fall in equity markets this year means that we are still able to find companies that we believe are both attractively valued and fulfil our other selection criteria. One example is Netflix, which we previously avoided due to elevated content costs as it built its own library, significant competition from legacy media companies, and a premium valuation. Now, the price has fallen to a level which mitigates these risks and creates potential upside from a transition to an advertising supported subscription service. Given this, we believe it to be a good addition to some of our portfolios.

Within the Sterling Bond Fund, the historic fall in prices has meant that our Fixed Income team are now more bullish on bonds than they have been in a decade. At one end of the scale there are some great yields available on short-dated bonds, such as a Thames Water bond, that matures in seven months and offers an annualised yield-to-maturity of 6%. We are however being very selective with any credit that we buy. Government bonds are now offering better yields than they have for years – you can now earn 5% nominal yield, or 2% real – and are still likely to offer protection to a portfolio if there is a major shock to equity markets, particularly the longer-dated bonds.

A textbook 60:40 portfolio has had its worst start to a year since World War Two, as both equity and bond markets have suffered. This has served to highlight the importance of diversification within a portfolio. Waverton’s two alternatives’ funds – the Real Assets Fund and the Absolute Return Fund – have provided this diversification and, in aggregate, have out-performed traditional asset classes this year.

Frustratingly, some sub-sectors of these strategies have also seen very poor performance so far this year, but in the wake of these revaluations there are some potentially great opportunities – the UK REIT market now trades close to its all-time discount to NAV and in all prior periods when discounts have been over 20% to NAV forward looking returns on a one, two and three year basis have been sharply higher.

Not only do alternative assets provide diversification within a portfolio, but some are well positioned to perform in the current environment of higher inflation and rising interest rates. Many have inflation-linked incomes while some, such as commodities, look to hold their value in real terms and benefit from changes in demand from infrastructure and technology. There are also sophisticated products that we are able to invest in that actively benefit from the rising rates.

We believe that our active, global, diversified and direct style of investment means that we are well positioned, and that even if we do see a material economic slowdown, we maintain good exposure to downside protection vehicles that will help to preserve capital for our clients.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Andrew Lloyd DipPFS

13/10/2022

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Stocks break three-week losing streak

Please see below ‘Markets in a Minute’ article received from Brewin Dolphin yesterday afternoon, which provides a global update on markets.

Most major stock markets rose last week as softer-than[1]expected US economic data raised hopes the Federal Reserve might slow its pace of interest rate hikes.

These hopes were quashed towards the end of the week as signs of labour market strength and a cut to oil production led to renewed inflation fears. After jumping 5.6% on Monday and Tuesday, its biggest two-day gain since 2020, the S&P 500 finished the week up 1.5%. The Dow and Nasdaq added 2.0% and 0.7%, respectively.

UK and European shares also rose, despite a jump in eurozone producer prices and signs of a deepening economic slowdown in Germany. The FTSE 100 gained 1.4% and Germany’s Dax rose 1.3%.

In Asia, Japan’s Nikkei surged 4.6%, although sentiment soured towards the end of the week following hawkish comments from US Federal Reserve officials. China’s stock markets were shut all week for the National Day / Golden Week holiday.

BoE doubles size of bond-buying programme

The Bank of England (BoE) announced on Monday (10 October) that it had doubled the size of its temporary bond-buying programme, which it introduced following the market turmoil created by the government’s mini[1]budget announcements.

The BoE doubled the size of daily auctions to a maximum of £10bn from £5bn previously, in an effort to “support an orderly end” of the scheme, which is due to conclude on 14 October. Chancellor Kwasi Kwarteng also confirmed yesterday that his medium-term fiscal plan would be brought forward from 23 November to 31 October.

The FTSE 100 slipped 0.5% on Monday as Russian attacks on the Ukrainian capital of Kyiv sparked concerns the war could escalate further. Wall Street stocks also declined after JPMorgan chief executive Jamie Dimon warned of a US recession in six to nine months. The downbeat mood continued into Tuesday, with the FTSE 100 down 0.8% at the start of trading.

US labour market remains strong

The release of the closely watched US nonfarm payrolls report last Friday cemented expectations that the Federal Reserve will increase interest rates by another 0.75 percentage points at its next meeting in November. Although the pace of jobs growth cooled in September, the unemployment rate unexpectedly dropped.

According to the Department of Labor, the US economy added 263,000 jobs in September. This was below than the 315,000 positions created in August, but was higher than forecasts for 250,000 new jobs.

The unemployment rate edged down to 3.5% from 3.7% the previous month, while the participation rate – the percentage of people working or actively looking for work – slipped to 62.3% from 62.4%, suggesting competition for workers is likely to remain high. Average hourly earnings increased by 0.3% month-on-month, but the annualised rise slowed slightly to 5.0% from 5.2% in August.

US services activity slows slightly

Economic activity in the US services sector slowed slightly in September, according to the Institute for Supply Management’s (ISM) purchasing managers’ index (PMI). The index measured 56.7 in September, which was 0.2 points lower than August’s reading of 56.9. The new orders index slipped to 60.6 from 61.8, while a gauge of prices paid by services industries for inputs dropped to 68.7, the lowest since January 2021.

It came after separate data from ISM showed US manufacturing activity grew at its slowest pace in nearly two-and-a-half years in September. The manufacturing PMI dropped to 50.9, reflecting “companies adjusting to potential future lower demand”, ISM said. A measure of prices paid by manufacturers dropped to 51.7, the lowest reading since June 2020, largely due to falling commodity prices.

Eurozone producer prices jump

Whereas US economic data showed some signs of easing inflationary pressures, the opposite was true in the eurozone. According to Eurostat, factory gate prices in August rose by 5.0% month-on-month and by 43.3% year-on-year, driven by increasing energy costs. Meanwhile, S&P Global’s eurozone composite PMI showed cost pressures intensified in September for the first time since March, again reflecting sharply rising energy costs as well as higher wages.

S&P Global said output in both the manufacturing and service sectors fell at a quicker rate in September as high inflation, soaring energy costs, rising economic uncertainty and weakening demand drove the euro area economy into a deeper contraction. Total new orders fell at the fastest rate in almost two years, while a considerable drop was seen in export sales.

German economic data worsens

In Germany, there were further signs the country could be heading for a recession. Retail sales fell by 1.3% in August from the previous month, worse than the 1.1% dip forecast by analysts in a Reuters poll. Meanwhile, import prices in August were 162.4% higher than a year ago, and industrial output declined 0.8% month-on[1]month, the sharpest fall since March. The German economy is expected to slide into a recession next year, according to reports by Reuters. Sources told the newswire that the government had cut its growth forecasts to 1.4% for 2022 and -0.4% for 2023, down from 2.2% and 2.5% previously. Official figures are due to be published on Wednesday.

Please check in again with us shortly for further relevant content and news.

Chloe

12/10/2022

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Weekly market commentary: Equities post reasonable gains despite volatility

Please find below, an update on markets from Brooks Macdonald, received yesterday afternoon – 10/10/2022

  • Equities soared early last week before being given a quick rebuke by central bank speakers
  • Last Friday’s employment report showed a strong labour market but declining participation
  • Thursday’s CPI release will be vital for the direction of equities and bonds over the coming weeks.

Equities soared early last week before being given a quick rebuke by central bank speakers

This week is expected to start in a quieter fashion after the volatility of last week. The US bond market is closed for Columbus Day, but equity markets remain open. The start of last week saw a rekindling of hope that the Federal Reserve (Fed) may pivot towards a more accommodative stance but by the end of the week central bank speakers convinced the market that it had been too eager to price in a change of policy. Overall equities posted reasonable gains over the course of the week however volatility remains a more consistent theme than direction.

Last Friday’s employment report showed a strong labour market but declining participation

The US employment report on Friday catalysed the latest leg lower for equities with the total number of new jobs coming broadly in line with consensus at 263,000 (255,000 consensus). The August dataset showed the labour force participation rate increase, a sign that employment conditions may have been tempting workers back into the workforce. The reading for September however, saw a reversal of some of those gains with the participation rate declining from 62.4% to 62.3%. News that jobs growth was stronger than expected but labour supply side issues remain was enough to drive equities sharply lower on the day.

Thursday’s CPI release will be vital for the direction of equities and bonds over the coming weeks

This week’s major market event will be the US Consumer Price Index (CPI) release on Thursday. The higher-than-expected US CPI release last month started a broad sell-off amongst equities and bonds. The market is expecting the CPI report for September to show Core (excluding energy and food) CPI to rise by 0.5% month-on-month and for that to lead the year-on-year rate to 6.5%  (compared to 6.3% for August). With US energy prices continuing to fall, headline CPI is expected to fall from 8.3% year-on-year to 8.1%.

Relatively few economists are expecting US CPI readings to rise dramatically from current levels, but there is still division as to whether inflation remains sticky, and will therefore plateau at an elevated level, or will begin to fall. Markets latched onto a new narrative around an accommodative Fed at the start of last week with little catalyst, we should therefore expect markets to overinterpret this week’s CPI release and extrapolate any upside or downside reading into the future. It is difficult to overstate the importance of Thursday’s US CPI release to market direction.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

David Purcell

11th October 2022

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Tatton Investment Management – Monday Digest: Reading the runes of October’s market bounce

Please see the below article from Tatton Investment Management, looking at the recent volatility in the market, and the performance of sterling. Received this morning – 10/10/2022.

Outlook: Reading the runes of October’s market bounce
As last week reminded us, volatile markets do not always swipe down, nor do they stay volatile forever. Monday and Tuesday saw a formidable ‘relief’ rally in global equities. Indeed, on Tuesday, US stocks recorded their biggest daily gain since 2020, leaving the S&P 500 up 5% by midweek. Stocks slid back toward the end of the week, but not by the same margin. Nor did they collapse after disappointing news of OPEC+ oil supply cuts. Indeed, the week felt like a microcosm of how the year has gone so far: down-trending capital markets ricocheting between recessionary fear and bear market rallies when hope takes hold that inflation is turning over.

There is much debate about whether a strong dollar causes weaker global growth, or is merely a sign of weak growth beyond the shores of the US economy. Historically, a strong dollar has coincided with weaker global trade, and while the rest of the world languishes, the US Federal Reserve (Fed)’s focus solely on domestic inflation pressures does very little to help the global economy. Last week’s comments from former Fed Chair Janet Yellen that talked of “global repercussions” to the Fed’s policies suggest the US is not totally unaware of its impact on international financial conditions.

Back to last week’s market action, the early-week positivity came perversely from news of weaker US employment data. US job openings fell by more than one million in August, the largest fall since the start of the pandemic. But, with the Fed still intent on crushing inflationary pressure by cooling wages, the bad news is good news as far as investors are concerned. The hope is that rising unemployment will give the Fed license to ease its grip, bringing the fabled ‘peak interest rates’ forward and setting the stage for looser financial conditions next year, as the Fed pivots away from raising rates further. 

Another oil shock in the pipeline?
On Wednesday, OPEC+ countries – led by Russia and Saudi Arabia – agreed to cut output targets by two million barrels per day from November. That represents about 2% of global oil production and, coming in the middle of rapid inflation across the western world, parallels have been drawn to the devastating oil shocks of the 1970s. As well as raising oil prices, Wednesday’s announcement knocked equity markets down on the fear of higher fuel costs, inflation, and lower growth. But the two million barrels per day cut applies to previously agreed targets, rather than actual pumping volumes. Given the gap between what most countries can produce and what they are allowed to, the hit to supplies will be considerably less. 

Crude prices above $100 per barrel would certainly bring unwanted inflationary pressure, but the likely increase is not so huge as to destabilise the world economy. Moreover, Saudi Arabia’s willingness to stick by Russia puts it on a political collision course with the US. We have already seen tensions between the Biden administration and the Kingdom’s Crown Prince, and further escalation could bring damaging uncertainties. One of the reasons for this is that the US arguably has the most to lose from higher oil prices. While Europe has struggled with natural gas supplies, its economy is much less sensitive to oil and refined fuel prices than the US, despite the latter’s access to shale production. American shale producers do not have the capacity to make up for global shortfalls or price jumps, particularly in light of President Biden’s shift towards renewable energy.

We don’t believe this drop in output is at the level of an oil price ‘shock’, but it could bring unwelcome volatility all the same. For now, it seems the US market is the main victim – not so good for global growth if it leads to a yet more hawkish Fed. However, the track of European natural gas prices remains the world’s most important energy price.

Europe’s fiscal in-fighting is just getting started
As for the UK, last week offered some respite – though not much. Gilt yields dropped back below 4% (they had touched 5% before the Bank of England (BoE) intervention the previous week) in tandem with the early-week equity rally. Sterling also recovered, reaching the $1.14 level it held before Chancellor Kwasi Kwarteng’s not-so-mini budget two weeks ago. Midweek jitters reversed these trends though, with yields rising and sterling falling into the weekend. Thankfully, these falls were not as severe as the chaos wrought in the last fortnight. 

Across the Channel, the European press pulled no punches when reporting on the UK drama. And for a group of countries where balancing the books is sacrosanct, such criticism made sense. Budgetary rules have been at the heart of European Union (EU) policies since the global financial crisis and Eurozone crisis, with some nations – such as Greece and Ireland – forced into stringent bailout programms. But if European leaders are concerned about loosening the public purse-strings at a time of rapid inflation, they can look no further than the continent’s largest economy. Just after the UK’s fiscal event fiasco, Germany announced a €200 billion ‘protective shield’ to help businesses and consumers cope with soaring energy costs this winter. The plan, much like Britain’s, will be funded by new borrowing and includes an emergency cap on gas and electricity prices. 

While Britain’s not-so-mini budget clearly put it well in front in terms of energy pricing spending commitments as a share of GDP, Germany’s latest spending programme – fiercely criticised by politicians across the Eurozone – leaves it not that far behind. More importantly, government commitments are high across all of the EU’s major economies (though not as high as the UK and Germany). These include fiscal commitments at or above 3% in France, Italy, and Spain – none of which enjoy Germany’s reputation for balanced budgets.

Within the European Central Bank (ECB), policymakers are already in the process of tightening monetary policy, and energy pressures in the winter will give the motivation to raise interest rates more severely. This is sure to make financing harder for European governments – at the exact moment, some are relaxing their debt constraints. With the EU’s fiscal star pupil Germany now loosening its grip on public finances, the temptation may be there for others to adopt similar tactics. Not only the ECB will be vigilant, but the bond vigilantes are likely to stand ready also.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Cyran Dorman

Trainee Paraplanner

10/10/2022


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Brooks Macdonald Daily Investment Bulletin

Please see today’s Daily Investment Bulletin from Brooks Macdonald received just now:

What has happened

Equities retreated yesterday as the Federal Reserve pushed back against market expectations for a rapid pivot from the US central bank.

US Payrolls

Markets are expecting 250,000 new jobs to have been created in the US in the month of September, a slight weakening from the 315,000 recorded in the previous month. The overall unemployment rate is expected to remain sticky at 3.7% although there is a high degree of uncertainty over the participation rate. The participation rate is the total labour force divided by the total working-age population and has remained low since the pandemic, exacerbating the labour supply shortage. In August the participation rate rose by 0.3% suggesting that higher wages were tempting workers back into the market but also perhaps that stockpiled cash from the pandemic was starting to run down, prompting workers to seek employment. How the participation rate evolves will be an important input into inflation numbers as well as the broader economic capacity of the US.

US Federal Reserve

The US employment report today will also be closely watched by the Fed who are looking to assess the tightness in the labour market and how that might impact both economic growth and inflation. Should the report continue to show US labour market strength then markets will conclude that the Fed is very likely to raise interest rates by 75bps at their next meeting. Yesterday saw another round of Fed Speakers, all of whom pushed back against the recent dovish repricing of Fed interest rate expectations. Minneapolis Fed President Kashkari said that ‘until I see some evidence that underlying inflation has solidly peaked and is hopefully headed back down, I’m not ready to declare a pause. I think we’re quite a ways away from a pause.’ This sentiment was backed up by several other Fed members suggesting a consensus at the Federal Reserve.

What does Brooks Macdonald think

In July and August markets began to price in a pivot from the Fed, expecting that economic growth fears would cause the bank to soften its tightening stance. The rally in equities and bonds was sustained for several weeks but ultimately unwound after Fed Chair Powell delivered his hawkish rebuke. Fed officials this time round are keen to act fast to reset market expectations rather than see a new, accommodative narrative start to gain more traction. Whilst this is clearly unwelcome to markets, as evidenced by the fresh risk-off tone, a clear message from the Fed now avoids any short term over-exuberance which may just be reversed in a few weeks’ time.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Andrew Lloyd DipPFS

07/10/2022

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AJ Bell: Why dollar strength and foreign exchange volatility is bad for stock markets

Please see below, an article from AJ Bell analysing the recent moves in foreign exchange markets and the implications for investors. Received this afternoon – 06/10/2022

After a relatively calm period foreign exchange markets have become a source of stock market uncertainty. Sharp moves in exchange rates are not conducive to international trade which has already suffered from the effects of the pandemic.

The recent 10% fall in sterling against the US dollar may help UK exporters (goods are cheaper for foreign buyers) but the other side of the coin is that imports become more expensive, contributing to inflation and reducing margins.

This puts pressure on the Bank of England to tighten policy when the government’s loose fiscal policy is pulling in the other direction. The same tussle is happening in the US and the EU. The divergence is contributing to currency volatility.

The clear winner has been the US dollar. The world’s reserve currency has been on fire, gaining around 20% against a broad basket of currencies.

Historically a strong dollar has been a harbinger of bad times to come. In 2008 the dollar gained 22% against that same basket of currencies amid the financial crisis and in 2020 on the eve of the pandemic it advanced 7%.

As a reserve currency the dollar is seen as a safe haven and investors tend to flock to it during times of market stress or fears of a downturn.

Morgan Stanley says every 1% increase in the value of the dollar reduces S&P 500 earnings by around 0.5%. It goes on to say the recent move in the greenback creates an ‘untenable situation for risk assets’ that has historically ended in a crisis.

The Japanese yen has fallen by more than a quarter this year to 24-year lows as the central bank sticks to an accommodative policy in contrast to most other banks.

Most commodities are priced in US dollars and its strength has made it more difficult for emerging economies which rely on importing food and other essentials. Several emerging economies also have foreign debts priced in dollars.

The Brazilian real and Mexican peso have held-up well with both currencies gaining against the US dollar, reflecting economic resilience and sought-after exports.

For investors with international portfolios, a weaker pound has increased the relative value of their foreign holdings.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Alex Kitteringham

6th October 2022

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Brewin Dolphin: Markets in a Minute

Please see below, a ‘Markets in a Minute’ update from Brewin Dolphin highlighting the key stories impacting markets around the world. Received yesterday afternoon – 04/10/2022

S&P 500 suffers third straight quarter of declines

Stocks continued their downward trajectory last week as the fallout from the mini-budget caused turmoil in UK financial markets.

The FTSE 100 lost 1.8% after the Bank of England (BoE) said the government’s new fiscal policy would require a “significant monetary response”, raising fears of a large interest rate increase in November. The panEuropean STOXX 600 and Germany’s Dax lost 0.7% and 1.4%, respectively.

Concerns about the UK’s financial stability weighed on stock markets in the US, where investors were also digesting news of higher-than-expected US inflation. The S&P 500 finished the week 2.9% lower, registering a third consecutive quarter of declines for the first time since 2009. The Dow lost 2.9% and the Nasdaq fell 2.7%.

In Japan, the Nikkei tumbled 4.5% to finish the week at a three-month low as the US dollar continued to strengthen against Asian currencies. China’s Shanghai Composite shed 2.1% after the Caixin/Markit manufacturing purchasing managers’ index fell to a lower-than-expected 48.1 in September.

Government scraps plan to axe top tax rate

The FTSE 100 edged up 0.2% on Monday (3 October) after the government scrapped plans to axe additionalrate income tax. Chancellor Kwasi Kwarteng said in a tweet that the proposed abolition of the 45% tax rate had “become a distraction for our overriding mission to tackle the challenges facing our country”. Kwarteng also announced that the publication of his medium-term fiscal plan would be brought forward from 23 November to the end of October.

The tax cut u-turn drove a decline in the US ten-year Treasury yield, which in turn boosted interest rate-sensitive growth stocks. The three major Wall Street indices ended Monday’s trading session more than two percentage points higher. The stock market rally continued into Tuesday, with the FTSE 100 and STOXX 600 up 1.3% and 1.8%, respectively, at the start of trading.

BoE takes action to stabilise markets

The BoE launched a temporary bond-buying programme last week in an attempt to restore orderly market conditions. It came after the tax-cutting measures in the mini-budget sparked a slump in the pound and a selloff in government bonds.

The Bank warned that if dysfunction in the long-dated government bond market continued, there would be a “material risk to UK financial stability”. It said it will buy bonds “on whatever scale is necessary” from 28 September until 14 October, and those purchases will be unwound once market conditions stabilise. The announcement last Wednesday had an immediate effect on 30-year bond yields, which fell back to 4.3% after rising above 5% earlier in the day. Although the BoE ruled out an emergency interest rate hike, it is expected to increase rates more aggressively at its next policy meeting in November.

UK avoids recession for now

In more positive news, revised economic data from the Office for National Statistics (ONS) implied the UK is not currently in a recession – defined as two consecutive quarters of declining gross domestic product (GDP). The figures showed GDP increased by 0.2% in the second quarter, instead of shrinking by 0.1% as previously estimated. There were increases in services and construction output, whereas production output fell. The data also showed that while household savings fell back in the second quarter, households saved more during and after the pandemic than previously estimated.

US inflation higher than expected

Over in the US, the Federal Reserve’s key inflation gauge, the core personal consumption expenditures price index (excluding food and energy), rose by an annualised 4.9% in August and by 0.6% from the previous month. Both figures marked an acceleration from a month earlier and exceeded economists’ forecasts, cementing expectations of further interest rate hikes.

There are signs that rate hikes are starting to impact the US housing sector. Pending home sales fell in August by 2.0% month-on-month and 24.2% year-on-year, according to the National Association of Realtors (NAB). The NAB said decade-high mortgage rates had “deeply cut into contract signings”. House prices, as measured by the S&P CoreLogic Case-Shiller Index, cooled between June and July at the fastest rate in the index’s history.

Eurozone inflation hits record 10%

Inflation in the eurozone hit a new record high for the 11th month running in September as energy bills continued to soar. Consumer prices rose 10.0% from a year ago, accelerating from August’s increase of 9.1%. Energy prices surged by 40.8% year-on-year, while food, alcohol and tobacco prices rose 11.8%, according to Eurostat’s flash estimate. Core inflation, which excludes energy and food, increased by 4.8%, up from 4.3% in August. Inflation in Germany hit a new 71-year high of 10.9%.

The figures came after European Central Bank president Christine Lagarde said the eurozone’s economic outlook was darkening and business activity was expected to slow substantially in the coming months.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Alex Kitteringham

5th October 2022