All eyes on US as US Federal Reserve's Janet Yellen hints at rate rise
It has been a relatively quiet week for global markets. Most developed markets traded in very narrow bands, other than Japan and China, which rose by 3% and 8% respectively. Even the Bank of England's so-called 'Super Thursday' was a relatively muted affair. Once again the Bank decided not to change interest rates or asset purchases. However, beneath the benign headlines, there were some interesting themes.
When the Bank of England's Andy Haldane visited Portadown recently, local business people highlighted the negative impact of strong sterling. Many Northern Ireland businesses have first-hand experience of how difficult it is to be price competitive with a close Euro neighbour. It is clear that the Bank of England, to a degree, shares the concerns on this currency strength. Consequent to the decision on interest rates, sterling did fall sharply and for UK businesses, this needs to be sustained. However, there is little to suggest that current European Central bank policy will lead to a stronger Euro.
The emerging consensus is that the first rate rise in the UK is now likely to be even later in 2016 than had been first thought. This is good news for borrowers and bad news for savers. In its inflation report, the Bank of England said that the 'outlook for global growth has weakened' and that 'CPI inflation is nonetheless expected to remain below 1% until the second half of next year.'
There was also a repetition of the view that, when the Bank does begin to increase rates, it is expected to do so more gradually and to a lower level than in recent cycles. On balance therefore, the Bank does not currently see the need to act quickly on interest rates.
However, the Bank of England does not work in splendid isolation and will no doubt be keeping a weather eye on events across the Atlantic. In the US, last week's labour market report was very strong. The US Federal Reserve's Janet Yellen has signalled that, in a robust employment environment, a US rate hike in December remains a real option. Accordingly, the market is now pricing for close to an 85% probability of a US interest rate rise in December. In this inter-connected economic world, the Bank of England will have to consider the prospects for US interest rates in their own deliberations. In currency terms the US may become a more attractive export market for UK businesses.
While the Bank of England does remain cautious on global growth, last week saw some tentative signs of a ‘bottoming out’ of the manufacturing slowdown in China. Survey data from Chinese manufacturing suggested improving confidence and a rise in new industrial orders. US industrial order levels have also improved. What does that mean for investors? While we are not out of the woods yet, if these leading indicators continue to improve, risk assets such as shares would be supported by improving medium term prospects for global growth. At this stage, focus on companies with good cash flow and strong balance sheets.
Jeremy Stewart is Head of Wealth Management and Private Banking at Danske Bank