Market Bulletin - Taper talk
Theresa May won her parliamentary vote on the Queen’s speech, as central bankers signalled that tightening had edged closer.
Twenty years ago last Saturday, Prince Charles and Governor Chris Patten boarded the Royal Yacht Britannia and sailed out of Hong Kong, formally ceding the last major remnant of the British Empire to the world’s new rising power.
Much has since changed. China has become the world’s second-largest economy and is, by many counts, set to overtake the US economy by 2020. As for Hong Kong itself, at the time of handover its economy was equivalent to 18% of mainland China’s – today that figure is below 3%.
Moreover, the Chinese economy has grown by at least 6% annually since 1991 – in 2007, when a certain subprime mortgage crisis was playing itself out in the US, the figure was 14.2%. Western economies, on the other hand, have seen the last ten years dominated by one major event: the global financial crisis. Central banks in Washington, Brussels and London continue to operate in the shadow of the crisis, and of the policies they introduced to limit its damage. Last week, leading central bankers indicated fresh willingness to finally wind down their post-crisis market support.
Mario Draghi expressed confidence that European Central Bank policies will help to spur “reflation”. His words raised expectations that the start of withdrawal of quantitative easing (known as ‘tapering’) was imminent – an autumn tapering of the programme is now widely anticipated. The euro rose in response, hitting a 52-week high against the dollar – although inflation figures released later in the week showed a dip in June to 1.3%, significantly below target, despite some signs of upward pressure on wages.
The eurozone can look to other tailwinds, however. Figures released last Monday showed that business confidence struck a new record high in June. The single currency area has seen the creation of six million jobs since the crisis and popular support for the EU appears relatively high, giving politicians a stronger hand.
“Approval for the EU has gone up since the EU exit referendum and the election of Donald Trump as US president,” said Stuart Mitchell of S. W. Mitchell Capital.
Yet worries over the withdrawal of central bank support pushed leading global indices down last week. The Nikkei 225 dipped 0.49% but it was the Eurofirst 300 that led the way, forfeiting 2.1%. For all the developments in inflation, jobs and growth, the underlying reality of central bank support remains fundamental to market sentiment – the global economy is now in debt to the tune of 327% of global GDP (up from 276% in 2007). Thus any signs of a slackening in support receive instant responses on the market. A rise in bond yields formed the initial response last week, closely followed by a fall in equities. And yet, of course, central bankers have talked this way before without following through.
The hesitancy of central bankers is perhaps especially apparent in the UK. Two weeks ago, Mark Carney had warned that rate rises would be dangerous due to sluggish wage growth and poor consumer demand. Signs of these struggles continued last week, as the GfK monthly barometer of consumer sentiment dipped to its lowest level since the aftermath of the EU exit referendum. Yet other indicators pointed to contrary pressures – the Office for National Statistics reported that, in the first three months of the year, the savings ratio fell below 2% for the first time in 50 years – and this happened despite a severe drop in consumer spending. As if on cue, Mark Carney warned last week that a rise in rates might in fact be needed, so long as business activity increased. The yield on two-year gilts – the most policy-sensitive government bonds – rose in response. The FTSE 100 fell 1.5% over the week.
The Bank of England also gave due attention to the banking sector last week, insisting that it maintain an extra £11 billion of capital to insulate it against future downturns. Carney said that the new levels shouldn’t be a challenge, but he did express concern that some lenders had grown increasingly reckless: “Consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier. And lenders may be placing undue weight on the recent performance of loans in benign conditions.”
Yet the UK banking sector may be on a rising trajectory, having made root-and-branch reforms since the global financial crisis – and having done so much more quickly than the eurozone’s financial sector. Neil Woodford believes that the pick-up in lending evident since late 2016 has been a positive dynamic, reflecting an improved UK economic outlook.
“We [now] find a banking system with substantially more capital than at any time in recent history… implying a much healthier banking system and one which clearly now feels confident enough to lend again,” says Neil Woodford of Woodford Investment Management. “Furthermore, despite the rehabilitation progress that the UK banks have made, share prices remain surprisingly close to the lows that coincided with the depths of the financial crisis in early 2009. Share prices tend to trade below book value too, which suggests that the stock market has yet to acknowledge the transformation of UK banks’ prospects that is now well underway.”
Yet if British banks are getting better at preparing for the future, a report published last week by the Office for National Statistics (ONS) suggests that British citizens are getting worse. The Wealth and Assets Survey found that, while most new savers are indeed using workplace auto-enrolment schemes, they are generally making no more than the minimum contribution – one percent of their salary. Despite employer matching, that implies a substantial drop in living standards during retirement. A separate report published by Prudential showed that women are especially vulnerable to retirement poverty – women retiring this year will be an average of £6,400 worse off per year than men; and the gap widened last year.
Speech not impeded
Meanwhile, political developments in Westminster continued apace. Theresa May succeeded in getting the Queen’s Speech through parliament and Nicola Sturgeon dropped her push for a second independence referendum for Scotland, at least until EU exit negotiations are concluded. Questions remain over what position the UK will take in negotiations. Last week the chancellor delivered a speech at the party conference of the CDU – Angela Merkel’s party – in which, having poked fun at the referendum campaign rhetoric of Boris Johnson, he appeared to leave the door ajar for the UK to remain in the customs union.
Back in London, Hammond and David Davis joined with Greg Clark, the business secretary, to set up a business advisory group for EU exit negotiations – perhaps a wise move, as figures last week showed investment in the UK car industry halved in the first half of 2017. This marks a departure for the May government, which had previously downplayed business concerns over Brexit. It also suggests that Hammond’s star may be rising.
Donald Trump’s fortunes appeared less happy last week. Google was handed a €2.4 billion antitrust fine by the European Union after a seven-year investigation, in the latest episode of transatlantic tensions. And the US president’s plan to repeal the ‘Obamacare’ suffered another delay on Republican resistance. The US also faced public criticism from China over the White House’s plan to slap tariffs on Chinese steel imports, a new arms deal with Taiwan, and sanctions placed on a Chinese bank.
Meanwhile, the dollar struck an eight-month low and the S&P 500 slipped 0.48%. Speaking in London, however, Janet Yellen suggested that the end of the post-crisis era was nearing as banks had strengthened so significantly, before adding that another such crisis was unlikely in “our lifetimes”.
Neil Woodford and Stuart Mitchell are fund managers for St. James’s Place.
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