Review of the week (week ending 6 October)

Sickly situation

Sterling has had a raucous few weeks. We have long noted that, following last year’s referendum, the currency has become the barometer of Brexit. It is also the political pulse of Theresa May’s government.

The pound is also sensitive to the Bank of England’s machinations. It always was, but Governor Mark Carney has been relatively muted since the vote. He’s been happy to let sterling fall, driving inflation further from the worrisome area around zero. There was also the chance that a weaker currency could boost UK exporters and manufacturing, although both the BoE and the Treasury didn’t really hold much hope that it would work. It didn’t. Instead, inflation swiftly overtook wage growth and the spending power of the people went into reverse once again. So, at the end of last month Mr Carney decided to give sterling a sudden shock: He warned darkly of exploding consumer debt and the need to raise rates to nip it in the bud. The pound soared.

But then the Conservative Party held its conference. And it was beset by problems. Having a cold is forgivable – as is going cheap on lettering for your slogans. These misfortunes would have been forgotten if there was a strong message underpinning it all. Expressing the general response, sterling tumbled back into a funk. It didn’t help that poor UK productivity growth is expected to blow a hole in government finances and car sales slumped by 9%.

So Mrs May has begun hinting at a Cabinet reshuffle to try breathe a bit of life into the government. Tellingly, most of the speculation around the affair is whether Foreign Secretary Boris Johnson will keep his job or not. Meanwhile, Brexit Secretary David Davis boards the train for Brussels as the fifth round of negotiations begin. Expect sterling to rise with good news from the joust and fall with the bad. 

 

Index1 week 3 months 6 months 1 year 
FTSE All-Share 2.0%3.8%5.6%12.5%
FTSE 1002.1% 3.6%5.1%11.8%
FTSE 2501.5%4.9%7.2%14.4%
FTSE SmallCap1.8% 4.8%9.0%19.2%
S&P 5004.0%5.3%4.2%15.9%
Euro Stoxx2.2%6.2%12.5%25.3%
Topix3.3%4.7%8.3%13.6%
Shanghai SE----
FTSE Emerging Index5.0%9.4%8.9%17.2%
Source: FE Analytics, data sterling total return to 6 October, *Shanghai Exchange closed for Golden Week

 

Big Kahuna

The gloomy pound is wonderful for UK equities though.

The FTSE All-Share was up 2.0% last week, large-caps finished even higher. All those overseas earnings are enticing. It was a good week for most stock markets, especially emerging markets and the Hang Seng Hong Kong index, which hit a 10-year high last week.

Optimism is building about US President Donald Trump’s ability to get a tax plan through Congress. If he does, it would be great for 2018 corporate earnings. It would also mean the repatriation of oceans of cash held offshore by American companies to avoid punishing taxes. About $920bn is held in untaxed cash overseas by S&P 500 companies, according to Goldman Sachs.

Exactly how much of an effect the repatriation would have is up for debate. Over the last few years, many companies have raised debt in the US, effectively backed by all offshore cash, to pay dividends and buy back shares. That has arguably already been repatriated. Also, there is a solid argument that says companies won’t invest simply because a slug of cash has been moved from one digital ledger to another. US companies already have huge onshore bank balances that they haven’t put to work. They need to find projects that can beat their cost of capital and these opportunities haven’t exactly been raining from the heavens lately. And given that discount rates are extremely low at the moment, rising interest rates shouldn’t make the pool of potential investments any bigger.

But such a large amount of money is bound to have some effect. Whether it’s window-dressing like refurbishing the office or perhaps greater research and development spending, in aggregate this should spur demand. They may use the money to reduce debt. Handing that cash back to shareholders could spark a consumption wave. Crudely, just the news that hundreds of billions of dollars is coming home is likely to bolster confidence in the US. It doesn’t necessarily have to have much of an effect of itself, sometimes sentiment and expectations alone do the job.

The tax plan as it stands would be terrible for the US budget deficit though. It means issuing trillions of dollars of extra debt over the next decade, which may put upward pressure on treasury yields. It would certainly inject more urgency into the US Federal Reserve’s rate tightening cycle – something chair Janet Yellen has acknowledged.

So the reflation trade is back on. Bank investors are on their surfboards, paddling eagerly in anticipation of the big wave. If rates do go up steadily, that will boost lenders by increasing the spread between what they pay to raise money and how much they can charge borrowers. Big banks Goldman Sachs, Bank of America Merrill Lynch, Wells Fargo and Citigroup have jumped about 10% in the past month in anticipation.

If US inflation leaps to 2.3% on Friday, as forecast, a 25-basis-point rate increase next month is almost locked in. If it is closer to the current print of 1.9% (or lower), this scenario will be in jeopardy. As for how quickly the Fed will move next year, one crucial variable is in the balance: who will be in charge? Rumours are rife that Mr Trump will dismiss Mrs Yellen when her term ends in four months’ time. Her deputy, Stanley Fischer, is resigning this month and the President has already appointed the deregulation-minded Randal Quarles to the board of governors.

Prediction markets point to Kevin Warsh being Mrs Yellen’ replacement. Mr Warsh was the youngest governor appointed to the Federal Reserve when he was picked by George W Bush in 2006. He quit in the aftermath of the global financial crisis because he disagreed with using quantitative easing to loosen monetary conditions beyond the bounds of interest rates. He is an unabashed hawk. Last year, he wrote in the Wall Street Journal: “The Fed often treats financial markets as a beast to be tamed, a cub to be coddled, or a market to be manipulated. It appears in thrall to financial markets, and financial markets are in thrall to the Fed, but only one will get the last word.” Warsh said, “A simple, troubling fact: From the beginning of 2008 to the present, more than half of the increase in the value of the S&P 500 occurred on the day of Federal Open Market Committee decisions."

We would debate that fact, although the Fed has definitely had an effect on the index. Still, this is an insight of Mr Warsh’s point of view. Mr Trump has four Fed seats, including Yellen’s, which he can fill with people of his choosing. This gives him massive influence over the form and spirit of US monetary policy for the better part of a generation.

Bonds

UK 10-Year yield @ 1.37%
US 10-Year yield @ 2.36%
Germany 10-Year yield @ 0.46%
Italy 10-Year yield @ 2.20%
Spain 10-Year yield @ 1.67%

Economic data and companies reporting for week commencing 9 October

Monday 9 October 2017

EU: GER: Industrial Production

Tuesday 10 October

UK: Manufacturing Production (Aug), Industrial Production (Aug), Trade Balance (Aug), NIESR GDP Estimate (Sep)
US: NFIB Small Business Optimism (Sep)
EU: GER: Trade Balance (Aug), Current Account Balance (Aug); FRA: Industrial Production (Aug), Manufacturing Production (Aug), ITA: Manufacturing Production (Aug) 

Quarterly production results: Vedanta Resources
Interim management statement: Robert Walters
Trading update: Marstons

Wednesday 11 October

US: MBA Mortgage Applications (6 Oct), FOMC Meeting Minutes

Interim management statement: Hargreaves Lansdown
Trading update: Jupiter Fund Management, Magnitogorsk Steel, Mondi, Page Group

Thursday 12 October

US: PPI (Sep), Initial Jobless Claims (7 Oct), Continuing Claims (30 Sep), Fed's Powell Speaks at IIF Conference in Washington
EU: Industrial Production (Aug); FRA: CPI (Sep)

Preliminary results: WH Smith
Quarterly results: Sky
Interim management statement: N Brown 
Trading update: Hays

Friday 13 October

US: CPI Ex Food and Energy (Sep), Retail Sales Ex Auto and Gas (Sep), University of Michigan Sentiment (Oct), Business Inventories (Aug), Fed's Evans Speaks on Economy and Monetary Policy 
EU: GER: CPI (Sep); ITA: CPI (Sep)

Quarterly results: Man Group
Interim management statement: PFG
Trading update: Ashmore Group

 

Julian Chillingworth, Chief Investment Officer

The value of investments and the income from them may go down as well as up and you may not get back your original investment. Past performance should not be seen as an indication of future performance. 

Rathbone Unit Trust Management Limited is authorised and regulated by the Financial Conduct Authority and a member of the IA. A member of the Rathbone Group. Registered office: 8 Finsbury Circus, London, EC2M 7AZ . Registered in England No. 02376568


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