Still sticking to the plan
Posted 3 May 2024
Equity and bond markets have had a reasonably good week, with policy makers helping to calm nerves. Geopolitical concerns retreated further; the US and Saudi Arabia are close to a bilateral agreement which may well include the formal recognition of Israel. Meanwhile, the first quarter’s results have been generally good, alongside some large buyback disbursements. Apple announced the largest ever forthcoming share purchase of $110bn, beating the previous largest by $10bn (which was also Apple in 2018).
The US Dollar slipped back after strong economic data from Europe and slightly less strong data from the US. It was also pushed lower by currency intervention by the Japanese Ministry of Finance, something some see as only a short-term stabilisation. The bigger factor was probably bond yields, with US yields falling and hence prices rising. The yield declines were most noticeable in shorter maturities.
Those yield falls were mostly because of the result of this week’s Federal Open Markets Committee (FOMC) monetary policy meeting. It had been highly anticipated, not for any rate move (there was none) but for the statement issued following the meeting and then, its chair, Jerome Powell’s press conference. We worried that FOMC members may conclude that financial conditions were too easy and that inflation is no longer coming down.
When asked about the Federal Reserve’s (Fed) view that inflation was on a downward trajectory, Powell reiterated comments from a fortnight ago that “So far this year, the data have not given us that greater confidence … It is likely that gaining such greater confidence will take longer than previously expected.” Although that sounded worrying, most investors saw it as mildly comforting. Bond yields have risen enough since the last meeting to discount a slower path of rate cuts.
Regarding the possibility of a hike, he said that it was “clear” that policy is currently providing restraint in a “number of places”. The Committee would need to see “persuasive evidence” that policy has stopped being restrictive in order to tighten.
Investor views of central bankers flip-flop between liking and loathing. Currently, the Fed chairman is a bit of a darling. On Wednesday, he told us that we shouldn’t worry, the US economy is being slowed gently. As if on cue, Friday’s employment report showed evidence that growth in jobs and pay has eased marginally.
We noted after the last meeting that the Fed seems to be determined to stick to the plan. They think the rate of inflation is still likely to decline towards the target and this week’s message, that the plan to cut rates is still on track, is clearly comforting for investors.
The message, and Friday’s employment data showing a slight rise in the unemployment rate to 3.9%, was enough to push the US 5-year treasury bond yield down sharply this week, from last Friday’s 4.70% to 4.45%, at the time of writing. The 0.25% fall is substantial and beneficial. At the same time, the economy is strong, as shown in solid sales growth – and the great news is that analysts are raising their margin expectations for next year as well. The pace of earnings-per-share upgrades is still accelerating as we go through the earnings season.
During last year, the US economy’s good fortunes did little for the rest of the world but, as we mentioned last week after the GDP data, perhaps that is changing. Europe’s economic data is starting to improve and, now, so are company results. Morgan Stanley’s Europe strategists show the chart to the left, identifying the growth in both sales and earnings outlooks (N12M is next twelve months).
This doesn’t change the outlook for rates and investors still expect a cut in June, with various ECB members making it clear that they too wish to stick to their plan. Below, we write about the European fiscal dilemma, which may start to be an issue for growth in the medium-term but, for now, things seem to be improving.
The UK, which is included in the broad Europe index shown above, has had three weeks of pretty great price performance, following a period of underperformance in the first quarter. Our economic data has also improved, as evidenced by the strong services Purchasing Manager Index for April. This was revised a little higher to 55 (from 54.9). 50 marks no growth, and 52 is usually associated with growth around potential (about +1% year-on-year for GDP) so this does indicate positivity. The recent poor weather has held back retail sales but perhaps businesses see sunshine ahead.
However, this may create an issue in its impact on next week’s Bank of England Monetary Policy Committee (MPC) meeting. Just as in the US, investors have adjusted expectations for rate cuts, factoring in a delay until September. The MPC has vocal hawks and they may have some sway this time around, which may reverse some of the strong FTSE 100 performance.
Meanwhile, The Times reported on Thursday that Coutts has switched almost £2 billion of client money out of the UK-listed companies and into global markets. The private bank is cutting (and probably has already cut) UK allocation in six client funds from as much as 40% to between 1.9% and 3.5%, depending on the fund. The Times quoted Charles Hall, head of research at Peel Hunt, who estimated that this represented a £1.96 billion switch out of the UK and a “very material” outflow. These outflows amounted to £8 billion for the whole of last year, according to figures from Calastone, a fund services provider.
UK companies are about 3.5% of global market capitalisation in the MSCI All-Country World Index, which is our usual reference index for global stocks. Internally, we also discuss this issue frequently and the arguments for and against a home bias are more complicated than just long-term return. However, it continues to indicate how the UK’s domestic capital market is shrinking, running counter to the small efforts made by the Chancellor in the Spring Budget. Clearly, if we wish to reverse the decline, something more fundamental needs to happen. We will write about reasons for and against a home bias in the near future.