Market Bulletin - Docking pay
Rate-setters in the US and UK diverged, while Emmanuel Macron won a large legislative majority and David Davis travelled to Brussels to begin EU exit talks.
Politicians may have been doing a fine job of looking amateur in recent months, but investors tend to reserve their strongest criticism for central bankers. In recent years, much of the criticism has been trained on the scale and timespan of quantitative easing programmes introduced after the global financial crisis. Investors worry that these programmes have distorted markets, potentially adding an artificial dimension to the second-longest bull run in US history (now 99 months’ old). Perhaps so, but they remain invested for the moment.
Last week, however, the Federal Reserve took a more hawkish line. On Wednesday, Janet Yellen announced the second US interest rate rise in 2017 – the fourth since the crisis – and forecast one further rise later this year, as well as the beginning of a plan to start unwinding its balance sheet before 2018. Although the June rate rise was widely priced in on markets, investors had not expected such a strong tack to the hawkish side in the Fed’s forward guidance.
Moreover, although the Fed continued to emphasise that its decisions are data-dependent, US data currently offers a mixed picture. Headline growth remains solid and employment remains high, but inflation and retail sales fell in May. The fall in inflation was particularly noteworthy, since it pushed it yet further below the Fed’s target level, potentially undermining the case for a rate rise.
Janet Yellen validated her committee’s decision on the expectation that the fall in inflation was temporary, and not the start of a trend. Markets felt somewhat differently, however, pricing in below-target inflation on a more sustained basis. Yet others were convinced by the logic for a rise, on the basis that longer-term indicators tell a more inflationary tale.
“We agree with Ms. Yellen,” said a note written by the Payden & Rygel economics team. “Look at the components of consumer price inflation, for example. We see that mobile phone plans shaved a surprisingly large 0.2 percentage points from headline inflation in May.”
Markets dipped in response to the rate decision, and US retail stocks took a hit on Friday on news that Amazon would acquire Whole Foods, a high-end American organic supermarket chain, for $13.7 billion, as the move pointed to the sector’s potential vulnerability to technology companies. The S&P 500 ended the week down 0.1%.
Prices vs wages
Meanwhile, the Bank of England’s Monetary Policy Committee struck a very different pose. Despite UK inflation rising to a four-year high of 2.9% in May – almost a whole point above the Bank’s target – Mark Carney et al chose to leave rates on hold last week. Even food prices in the UK are now rising, after a three-year slide. When UK inflation reaches 3%, the central bank governor is obliged to pen a letter to the Treasury to explain why the target has been so strongly breached. It is notable that retail price inflation – which includes housing costs excluded in the consumer price calculations – is already at 3.7%. The FTSE 100 dipped 0.8% last week.
Yet markets hadn’t expected a rate rise and the surprise came instead via a split vote – three of the eight committee members voted to push interest rates up, the closest the Bank has come to raising rates since 2007. Although inflation is indeed high, there are other reasons that the Bank found to hold fire. One is continued political instability, both governmental and in terms of EU exit negotiations. Another is the economic growth rate, which in the first quarter was the lowest of all 28 EU countries. A third is a dip in non-food sales, suggesting that retail sentiment is flagging – DFS’s poor results, announced last week, offered one example of the impact. A final challenge is wage growth, which has now fallen significantly behind price growth.
The average basic weekly wage is in fact down slightly from where it was in March 2008 – this represents the longest stagnation in UK wages in living memory. Recent research published by the Resolution Foundation shows that the 2010s are on course to be the worst decade for UK wages since the first decade of the 19th century. To some, this is the flip side of the UK’s high employment figures. To the Bank of England, it may have provided one more reason to hold off on any tightening measures.
Such trends do not make for happy reading, especially for those just starting their careers, as they point to a marked shift in the balance of wealth towards the older generation – the asset owners. Yet research published last week by Key Retirement showed that nearly two out of five people are not aware that gifts to family members could be liable for Inheritance Tax. Many also didn’t know that they could give away £3,000 per year tax-free or make tax-free gifts to couples getting married. Yet the poll found that nearly six out of ten people want to be able to help children and grandchildren get onto the property ladder.
Furthermore, research conducted by St. James’s Place and Capital Economics has found that every £1 of wealth transferred between the generations could add £1.65 to the UK economy. The study found that there is an estimated £6.6 trillion of wealth held by those aged 55 and over in the UK. The figures show £2.8 trillion of the total is expected to be available for transfer over the next 30 years, adding £677 billion to the economy – equivalent to 1.2% of GDP each year.
For those considering how best to save, invest, protect and pass on their wealth, this Wednesday may provide several reasons to take action, as the Queen delivers her (postponed) speech to open parliament. Since the Conservatives failed to win a majority, the contents of the speech should reflect whatever deal is struck between the Conservatives and Northern Ireland’s Democratic Unionist Party (DUP). That may have implications for all kinds of issues, from the State Pension triple lock (which the DUP favours keeping) to the dividend allowance.
It should also indicate the government’s intended direction of travel on EU exit negotiations. Last week, two of the four ministers in the government’s EU exit department quit their posts, while a poll showed that 43% of non-UK City workers plan to leave the UK before 2019, the year set for the UK’s exit. The UK chancellor, apparently emboldened by the prime minister’s electoral disappointments, warned last week that business concerns must be at the centre of the UK’s approach to exit negotiations, and that a departure from the EU without a deal would be “a very, very bad outcome for Britain”. Meanwhile, the previous prime minister and chancellor both offered their own public criticisms of ‘hard Brexit’ policies.
David Davis, UK lead negotiator in exit talks, has already arrived in Brussels, where discussions begin today – Theresa May will follow on Thursday. The initial focus of disagreement is expected to be ‘sequencing’ – whether the UK has to stick to the pre-established order of negotiations, thereby resolving the size of the exit bill and citizens’ rights issues ahead of other matters.
All such challenges were overshadowed, however, by the Grenfell Tower disaster of last Wednesday in Kensington, which is now reckoned to have claimed at least 79 lives, and continues to cast a pall over the nation. A terror attack in North London on Sunday night added to the sense of instability.
Meanwhile, the new French president met with Theresa May last week to hold discussions ahead of an overwhelming win in France’s legislative elections over the weekend – his party took 350 of the 577 seats available, although turnout was low. The scale of the win gives him strong backing to proceed with his plans to reform France’s long-unreformed labour market.
Eurozone economic and corporate indicators remain buoyant – last week strong industrial output figures added to the sense of momentum. The Eurofirst 300 dipped 0.5% last week, partly on news of the Fed’s rate rise plans. But the index has risen almost 8% this year, reflecting growing confidence in the currency bloc’s outlook – it has been a good year for investors with holdings in Europe. Last week, a deal was struck to ensure that Greece could meet its summer debt repayment obligations without defaulting – success in terms of a crisis averted, although not yet the beginning of a long-term resolution.
Payden & Rygel is a fund manager for St. James’s Place.
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