Brexit and the UK consumer with Investec UK Alpha
Managing Director, Darius McDermott, discusses Brexit uncertainty and choppy outlook for 2019 with...
It’s been something of a topsy-turvy ride for equities in May. European markets were flat, the UK and US edged up a touch, but Asia Pacific and emerging markets were down; the latter on renewed strength of the dollar.
We break down the key events, market by market, that you need to know about in June.
The UK economy has been ticking along OK, pretty much in positive territory for some time now, although compared with recovery phases from previous recessions it is a rather anaemic affair.
One could observe that the long-term trend in GDP growth has been down for some decades now.
There is little point speculating on the trend post the referendum in my opinion, but by the time I write next month we should finally have a better idea of where the UK might be headed after months of Brexit-related uncertainty.
Having soothed the markets with suggestions the economy was still a little too fragile to stand more than one rate rise this year, the US Federal Reserve (the Fed) now seems to be saying that two, if not three, rises might still be on the cards. This has had the effect of pushing equity markets back down and the dollar sharply higher. It seems clear that Fed chairwoman Janet Yellen’s in-built dovishness is being challenged.
Everyone at the Fed knows that in the normal course of events interest rates would be much higher (around 2% –3%), but that the ever-growing burden of debt can only be serviced with rates at their current very low levels. The alternative is debt forgiveness, involving some pretty heroic write offs, which the Fed is just not prepared to contemplate yet. The hawks would at least like to see a token rise, however, which is probably what they will get.
There has been a suggestion that the Fed is not keen to move just 8 days before the Brexit referendum for fear the markets may take flight, giving impetus to the leave vote which, in turn, would cause a further short-term hiatus at the very least. As the bookies don’t give Brexit much of a chance and given the recent hawkish comments, it seems that the markets are being softened up for a 25bps rise on the 15th.
Trump is on a roll and Hillary is fighting for her political career, but is a survivor if nothing else. Electioneering will hold most people’s attention between now and November – nearly six months of it to go! The Fed will of course get a word in and dollar strength may have unintended consequences; China is the known unknown in this instance. The yuan has been gently trading down, but a sharper ‘devaluation’ would be an upset for the markets.
The Euronauts are doing all they can to avoid Brexit becoming a reality, mainly by issuing dire threats, which is their normal modus operandi when things aren’t going their way. President of the European Commission, Jean-Claude Juncker, has suggested that were we to leave he wouldn’t be doing us any favours in negotiating our way out.
What might be equally revealing would be his attitude toward the UK should we vote to remain, given our stance on political union. European markets will be affected by the referendum outcome in much the same way as the UK.
Perhaps unsurprisingly, prime minister Shinzo Abe has postponed the second 3% sales tax hike as the economy has failed to respond to the Bank of Japan’s move to negative interest rates.
As we are seeing in Europe, where negative rates are the latest ‘experiment’, savers are not spending, but actually saving more, which is an inbuilt Japanese trait even in the good times (which of course few can remember). A stronger dollar would be a great help as the yen has also not performed as expected under the new rate regime.
Having had a good start to 2016, these markets suffered from ‘sell in May’ syndrome last month. Partly on profit taking, but mainly on the renaissance of dollar strength.
Brazil and Russia, both oil and commodity related, have suffered the most, as one would expect, but India’s renaissance continues.
The world continues to worry about Chinese debt levels, but in a state controlled economy they can carry on for a long time yet before the wheels fall off.
Gold continues in its corrective phase, but the down moves are less than dramatic now that the longer-term trend appears to be up. Any fall in price is seen as a buying opportunity not an excuse to sell more. The miners, as ever, are showing more volatility, but again an opportunity to accumulate.
The oil price has hit $50—see chart for an historical perspective—and a consolidation at the very least is expected, although continued dollar strength will push it back down again. There is still massive supply, despite less coming from the shale frackers, and the recent rise has been more about squeezing the shorts than real economic demand.
Over $70 trillion of global bonds are priced at negative yields and the 35-year US treasury bull market remains unabated – see chart opposite. Deflation has returned to Japan and is adjacent in Europe.
High yield bonds are still priced like equities and will behave like them when the markets take flight. With the European Central Bank and the Bank of Japan still trying to corner the market, bonds remain the favourite ‘risk-off’ play, but for how much longer?