If one wants to follow the financial markets, what should they use? The Financial Times? The Wall Street Journal? Bloomberg? Thomson Reuters? The Economist? There are 1000s of articles out there, most going into greater depth than needed. Here’s a concise summary of what is going on in the financial world today:
US Interest Rates
Ten days ago, the US Federal Open Markets Committee (FOMC) raised the key Fed Funds rate by 0.25% to take the new band to 0.75 -1.00%. This move was fully discounted by the market after various Fed officials monetary policy comments in the run up to the FOMC meeting.
The markets are expecting two further 0.25% interest rate rises this year and three such rises next year. This fits in with the Federal Reserve desire to ‘normalise’ interest rates rather than still be facilitating emergency level, post-financial crisis, low levels of rates. The market actually interpreted the Fed comments after the meeting as ‘dovish’ i.e. softer in nature, with little sign of an aggressive interest rate rising policy. The dollar sold off on this accordingly.
Analysis: Such a steady rise in interest rates assumes Trump-inspired robust US economic growth over the next couple of years. However, after the Trump administration’s failure last week to get healthcare reforms i.e .the repeal of Obamacare, through Congress (see below) a strong US economy going forward is far from certain – the Fed might need to hold interest rates ‘lower for longer’.
Overall, the dollar has been strong over the last couple of years. The US Dollar Index (a measure of the ‘Greenback’ versus a basket of foreign currencies) hit a 14-year high in January at 103.82. Compare this to a value of only 93.0 last April and, in fact, 80.0 in 2014 – the dollar has risen 20% since 2014 all based on a relatively strong economic outlook and a rising interest rate environment. However, this dollar rally has seen profit-taking or a ‘pause for breath’ so far in 2017, falling from January’s 103.82 to 100.00 now.
Analysis: The 3.82% fall in the ‘Greenback’ this year may well be a buying opportunity as the US economy is the only Western developed country showing anything like normal economic growth. Additionally, the UK and Europe both have significant political challenges ahead. Perhaps ‘buy the dollar on dips’ is the way forward.
US stocks have also paused for breath, with the S&P 500, Dow Jones Industrial Average and the NASDAQ all holding 1 or 2% below record levels. Investors are reluctant to take the markets higher after the failure of the Trump administration to secure the passage of the crucial healthcare reforms at the end of last week.
This sent a wave of risk aversion rippling through global markets. Participants fretted about the ability of Donald Trump to enact the rest of his economic agenda – most notably tax cuts and infrastructure spending – on the back of this setback. However, looking at the bigger picture, the first quarter of 2017 was a good one for global equities rising 6.7% – the strongest three months since 2013.
Analysis: The US equity market feels like a bull market. That is the problem – investor sentiment is way too one-sided and there is an awful lot of good news priced into the market. Should the failure of healthcare reforms be indicative of future legislative policy problems, investors could be very exposed holding US equities. As Warren Buffett said: “Only when the tide goes out do you see who is swimming naked”.
In such a recent ‘risk-off’ US investment environment, some money has been flowing back into bonds (traditionally viewed as a safer investment). Consequently, yields on most bond markets have fallen over the last ten days (prices, therefore, up), with the benchmark US 10-year government bond moving from a 2.60% yield-to-maturity to 2.40%.
Bond yields are higher in the US than in Europe as the former is witnessing an economic upturn and rising interest rates and the latter is still trying to kick-start economic engines. Subsequently, UK 10-year bonds yield 1.13% YTM, and German 10-year Bunds yield 0.40% YTM. 2-year German Bunds are still in demand as a safe haven asset with lingering concerns over French elections and yield -0.75% YTM.
Analysis: The 10-year US Treasury Bond has risen over 1.2% (120 ‘basis points’) since last summer. A 2.40% yield offers no value with the prospect of the return of inflation after significant amounts of global quantitative easing over the last five years.
Oil has traded reasonably close to $50 per barrel ever since the agreement in November, both internally within OPEC (led by Saudi Arabia) and externally with Russia, to cut production. This agreement seems to be holding and it is possible, should this continue to be the case, that oil moves towards the $60 per barrel level.
It is, however, hard to see oil moving above this threshold as US shale producers (extracting oil and gas from pockets within rock formations) will likely ramp-up production, which they have the production flexibility to do, with oil production costs in the 40-50 dollars per barrel region for shale producers.
It is hard to imagine oil breaking out of the $40-60 range anytime soon. Gold has also remained reasonably steady around $1250 per ounce. Gold is another ‘safe-haven’ asset as it has been around as a means of investment for 5000 years and will likely still be one for the next 5000.
Analysis: US Shale producers are just too nimble. As that industry matures, production becomes more efficient and the cost of that production keeps on falling. This means $50 not $60 becomes profitable for US drillers. A structural increase in supply means one will never ever see oil at $100 per barrel again.
A final word on Theresa May triggering Article 50 last week. This was no surprise, and therefore, had no impact on the markets. However, no doubt, UK financial markets will react to every significant development that takes place in this two-year story. Foreign investors might just wait for the story to end before making major UK capital commitments.
Analysis: Perhaps FTSE 100 companies represent a smart ‘win-win’ investment. If global equity markets perform, the FTSE 100 will likely participate in this move. If Brexit negotiations become problematic, the British pound will fall, causing FTSE 100 companies to benefit as they translate their significant overseas earnings back into pounds at more favourable exchange rates – i.e. increased UK company profits.