Michael Ford

Summary

It has been another volatile week for equity markets, with many indices down 4%.

The Federal Open Market Committee (FOMC) raised its policy rate band by 25bp as expected, but the move was seen as a “dovish hike”.

FOMC news was overshadowed by an escalation of the US-China trade dispute, and the fear that this would widen.

Next week attention will remain on trade, but will also move to Federal Reserve (Fed) speakers and global inflation releases.

Market and economic review

Trade wars and policy decisions: FOMC not as hawkish as expected, trade dispute with China escalates

We started the week with equity markets a little nervous ahead of the Federal Open Market Committee (FOMC) rate decision, and still worrying about the potential for a widespread trade war to materialise. UK equities had a notably tough start, with the announcement that a transition agreement had been reached with the European Union that would delay Brexit by 21 months. It was also announced that a large part of the exit treaty had been settled. While this was positive news for the UK economy, and therefore the currency, the resulting rally in sterling hurt UK risk assets. The FTSE 100 Index fell over 1% in response to the news.

As we approached the close of business UK time on Monday, the US equity market sold off sharply, as tech stock prices fell dramatically in response to allegations that Facebook had misused users’ personal details (most significantly to help the Trump election campaign). Around $37bn was wiped off the value of the stock. Nervousness generated by this appears to have spread to the wider market, with the S&P 500 Index closing down almost 1.5% on the day. This weakness fed through into Asian markets in the following session.

With that as a backdrop, markets went into the FOMC announcement concerned that Jay Powell would use his first meeting as Chair to send a more hawkish rate message to markets. In the event, the policy rate band was raised 25bp as expected, but the overall impact of the accompanying comments and statement was viewed as slightly dovish. The Committee still expects to raise rates a total of three times this year (though it was a close run thing versus four hikes). An additional hike has been pencilled in for 2019, but markets appear to think that was offset by the fact that the Chair said the FOMC wanted to take the “middle ground”; mentioned the flatness of the Phillips Curve with respect to low wage growth; and said there was no sense that inflation was on the cusp of moving higher.

Markets also took the view that the FOMC continued to see risks to its forecast as roughly balanced, and that it was relaxed about small overshoots of its core inflation target in 2019 and 2020 as indicative of a more-dovish-than-feared outlook (some thought the removal of the word “roughly” would indicate more hawkishness). Fixed income and currency markets reacted as expected on that view, but equities didn’t rally. Asian markets reacted similarly in the following session – apparently reflecting nervousness over a likely escalating trade war in light of Trump’s decision to impose more trade restrictions on China (and China’s threat to respond in kind).

On Thursday the details of those restrictions – 25% tariffs on around $60bn of US imports from China, plus a plan to make it harder for China to buy into key US corporates – were made clear. These, plus China’s response – restrictions on 128 products/$3bn of imports from the US – plus a threat that they would continue to escalate and could hold out longer than the US in any spiralling trade war, spooked markets significantly. Add to this the news that the US would be making a complaint to the World Trade Organisation over China’s technology licencing rules, and, that a known foreign policy hawk had become the new National Security Advisor, and that was enough to see the S&P 500 Index close down 2.5%. Larger falls were seen in the following Asian session across a number of bourses as this story emerged and developed. The Nikkei 225 Index was worst affected, suffering a 4.5% drawdown as the Japanese yen was bid up for its perceived safe haven value. Time will tell how this all ultimately plays out. There appear to be a number of high ranking Republicans and corporate leaders who are against the measures. In the normal course of events, that would probably be enough to at least soften any proposed measures. But, with the current President, who knows?

The Bank of England leaves rates unchanged but expected to raise rates in May

The Bank of England (BOE) left the bank rate at 0.5%, as was widely expected. Financial markets continue to expect the BOE to raise rates by 25bp in May. At the time of writing, early Friday morning UK time, financial markets think there is a 20% chance of a hike in April, a 67% probability of an increase in May, and a 75% chance of a rise in June. With the impact of a weaker exchange rate on inflation starting to drop out of the key inflation metrics, we continue to think there is less need for a rate hike than both the Bank and markets believe.

Data: moderating growth with limited inflationary pressures

The usual wide mix of data was released from around the globe over the week. Fairly obviously, not all of this had a consistent theme, but, if we had to draw one out, it would be one of moderating growth with limited inflationary pressures. On the growth front, preliminary purchasing manager’s indices in Japan, Germany, and France were all down and lower-than-expected. In Germany, key balances in the ZEW index and IFO surveys fell. On the price front, German producer price inflation was down and lower-than-expected (at 1.8%, from 2.1%), as were UK producer price and consumer price inflation (CPI). The UK labour market release was fairly firm, but core earnings growth edged up only slightly to 2.6%.

Outlook

A fairly light week: Fed speakers and PCE inflation the highlights

The key focus next week should be whether or not there are any developments in the fledgling US-China trade dispute. At this stage, where “opening statements” have just been made, it seems unlikely there will be a significant reversal of positions. On the data front, after the excitement surrounding the FOMC rate decision and new dot plot, we have the “calm after the storm”. There is little in the way of key data released around the globe. In the US, regional Fed surveys and the personal consumption expenditures inflation numbers for February are the highlights – as are speeches by FOMC members Dudley, Mester, Quarles, Bostic and Harker. Comments made could provide more clarity on where the FOMC currently sits with respect to its rate view – though the usual mix of opinion seems more likely to us. In Europe, provisional CPIs for March will be released at the end of the week. We expect these to continue to point to limited inflationary pressure. In the UK, the highlight is probably the CBI distributive trades survey that will give the latest steer on conditions on the high street and the ongoing impact of online shopping on more traditional retailers.

By Michael Ford, portfolio manager in the multi-asset strategy group

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