Key Investment Themes – August 2019, with Barney Hawkins, Investment Director
Hello. My name is Barney Hawkins, Investment Director at True Potential.
Volatility, which has been absent for so long, is back. As predicted.
Markets have been ruffled by a number of factors, most notably the ongoing trade wars between the United States and China, signs of a gentle slowing in the pace of global growth and a series of technical factors in the bond markets.
In a sign of increasing risk aversion, the sovereign bonds (government IOUs) of Japan and several European governments are trading on negative yields. Investors are, in effect, paying to lend money to these governments.
In a further twist, the yield curve on the US and numerous other bond markets has become “inverted”, meaning that investors are receiving a higher return on short dated bonds than they are on longer dated maturities. Generally it works the other way round. Like a building society deposit account, the longer you are prepared to wait for the bond to mature, the higher return you can expect.
An inverted yield curve has, for some people, been an indicator of a possible recession. However, this time the effect has occurred when all the data points to a US economy which looks to be in rude health. It’s growing at over 2% per annum, consumer confidence is high and inflation remains subdued.
So, if the US economy is so strong, why are bond markets attracting so much attention?
Well, much of the answer lies in the increasingly fractious trade negotiations between China and the United States. In the latest exchange, Trump’s threat of higher tariffs was met by China allowing its currency to fall below the rate of 7 renminbi to the dollar: now that’s a symbolically important level that China has always taken pains to defend.
The devaluation was a calculated move, designed to demonstrate to the US authorities that any hike in tariffs (which would make Chinese goods more expensive to US consumers) could be countered by the Chinese allowing their currency to fall against the dollar, thereby lowering the cost of their exports.
Now with this tit for tat two step showing no sign of easing, the US Federal Reserve is faced with the almost impossible task of setting interest rates.
On the one hand, if there is no easing of tension with China then, arguably, the Fed might be able to justify a cut in rates to stimulate the US economy and promote growth in the wider, global economy.
On the other hand, if there is a rapprochement with China then, in theory, no stimulus would be required from the central bank and its most recent programme of rate tightening could probably resume.
A central banker’s life, at least in the US, is not an easy one.
However, in the multi asset world, where there is threat there lies opportunity and a cut in rates is likely to be viewed very positively by equity markets around the world. Also the notion of interest rates being “lower for longer” should serve to prolong the business cycle, again, supporting both equity and bond markets.
For their own part our managers remain sanguine. No one is forecasting recession and around Brexit the view is that an eleventh hour deal will be done.
Central banks have made it plain they will act to maintain the current upturn for as long as possible. Two, possibly three cuts in US interest rates are predicted by the year end with the European Central Bank expected to ease in September and Mark Carney, Governor of the Bank of England, expected to announce a cut in UK rates after the October 31st Brexit deadline.
In addition, China is forecast to implement a further economic stimulus in response to the ongoing trade wars; Angela Merkel, the German Chancellor, is set to unveil a 50 billion euros worth of measures designed to support the German Economy and Boris Johnson has already promised a raft of pay increases and public spending initiatives as he prepares for the UK’s departure from the EU (and his own election campaign).
As autumn approaches it’s likely that volatility will remain. But, as we enter the run up to the US Presidential election in 2020 you can be certain that assured that politicians, business leaders and central banks will be doing all they can to prolong the current upturn.
Thanks for listening.