The British pound rallied +1.3% on Thursday shown on the first chart below, as the Bank of England left interest rates unchanged at the record low of 0.25% and a London court ruled that Prime Minister Theresa May could not trigger article 50 to begin withdrawing the UK from the EU without a vote by parliament. This now sets up a challenge of this ruling at the Supreme court in early December. Failure for this to be overturned would then require parliament to vote on measures prior to triggering article 50 and that will help alleviate some of the more “hard Brexit” concerns.
The Bank of England left rates unchanged as widely expected, what investors were focused on was the language accompanying the decision as well as the quarterly inflation report. The language was very much in line with market expectations, inflation has increased faster than expected and has attracted the attention of the nine person monetary policy committee. The statements notes that “there are limits to the extent to which above-target inflation can be tolerated” with those limits depending on the cause of the overshoot. The committee also note that monetary policy will continue to be dependent “upon supply, demand, the exchange rate and inflation with the ability to respond in either direction, to changes to the economic outlook:”
Still the prospect of a rate hike looks unlikely, the cause for the drop in the Pound and rise in inflation likely to prove temporary and “attempting to offset it fully with together monetary policy would be excessively costly in terms of forgone output and employment growth”. Overall the Bank of England is likely to keep monetary policy unchanged over the coming months, but stands by with its finger on the trigger ready to add stimulus if necessary.
Looking to the updated inflation report, inflation forecasts for 2016 to increase to 1.3% from .2%, while both 2017 & 2018 were also revised higher to 2.7% from 2.0% & 2.4% previously before settling around 2.5% in 2019. GDP forecasts for 2016 & 2017 were also revised higher to 2.2% & 1.4% from 2% & 0.8% respectively while 2018 guidance was lowered to 1.5% from 1.8% as the uncertainty around the U.K’s withdrawal from the EU is still expected to weigh on the economy. Unemployment for 2016 was revised lower to 4.9% from 5.1% as was 2017 from 5.5% to 5.4%, while the 2018 figure was revised higher to 5.6% from 5.5%.
As a result U.K. bond yields rose, the two-year gained +1 basis point to +0.19% while the ten-year yield was +3 basis points higher at +1.199%. Equity markets were mixed with the FTSE100 closing -0.80% lower while the FTSE250 was +0.68% higher.
In mainland Europe the unemployment rate (MoM Sep) remained stable at 10% in line with market expectations as we continue to see further signs of stabilisation from the EU. The Euro was modestly higher against the U.S. dollar, up 0.1% and equity markets were broadly lower, the DAX declining -0.43% while the Euro Stoxx 600 was unchanged. The two-year yield on German government bonds were unchanged around -0.631% while the ten-year yield which is more sensitive to inflation expectations rose +3 basis points to +0.159%.
In the US nervousness around the presidential election continues to weigh on sentiment as Hillary Clinton’s lead in the polls continues to narrow. National polling average data provided by FiveThirtyEight has Clinton leading with 48.4% of the vote against Trump’s 45.3% translating into a 64.7% probability that Clinton wins, down from 87.3% at the third presidential debate. A separate poll tracker by the New York Times has Clinton leading 45.7% to Trump’s 42.6% placing Hilary’s odds of winning at 86%.
It’s difficult to say the exact market reactions to either outcome, but my thoughts are as follows:
If Clinton wins we’ll likely see a selloff in US treasuries as the market adopts a risk-on mentality. The US dollar should strengthen against major currencies particularly the yen & Euro. Banks, insurers and drug makers will likely underperform given her toughen stance towards Wall Street and criticism over drug price hikes. Clinton’s policies are also more environmentally friendly and that would weigh on fossil fuels such as Crude Oil and coal.
In a Trump victory in a clear risk-off mentality two-year U.S. treasuries would likely outperform with inflation protected securities as investors seek safety. The U.S. dollar would fall against majors, particularly safe havens such as the Yen and Swiss Franc. Longer-terms bond yields would likely spike higher given Trump’s inflationary policies, the Mexican peso and Yuan would come under pressure given his protectionist policies and comments around trade with both Mexico & China. Emerging markets would also likely come under pressure as a result of the more protectionist stance towards trade. Gold would rally and Silver would also benefit from this. In terms of equities it would be the opposite of Clinton, banks, insurers and drug makers would likely outperform along with fossil fuels, basic materials and construction companies on expectations of more infrastructure spending. Meanwhile care providers would underperform as he would repeal Obamacare.
U.S. equity markets were lower once again overnight, both the S&P 500 & Nasdaq 100 declining -0.44% & -1.01% respectively with declines in technology (-0.99%0 and healthcare (-0.89%) more than offsetting modest gains in utilities (+0.35%) and energy (+0.35%). The U.S. dollar index was -0.27% weaker, two-year treasury yields declined -1 basis point to +0.8095% while the ten-year yield rose +1 basis point to +1.8115%.
The second chart below shows the S&P500 index along with the VIX which is a fear gauge, this image highlights the inverse relationship between the two, that there is a great deal of fear in the market (elevated VIX) when the S&P500 moves lower. We can see a number of spikes towards the 30-35 region of the VIX which tend to coincide with a bottom in the S&P500. I’m not saying that this is necessarily the case and that I expected the S&P500 to bounce sharply higher, however it does highlight that there is an increasing amount of fear in the market.
There was a raft of data from the U.S. overnight, the ISM Serivces/Non-manufacturing composite (MoM Oct) missed expectations of 56 with a reading of 54.8, down from 57.1 previously. Factory orders (MoM Sep) rose +0.3% surpassing estimates of +0.2% while durable goods orders (MoM Sep) missed expectations of -0.1% with a decline of -0.3%. Month-to-month readings of these indicators can be quite volatile so they aren’t too concerning given the larger trends are in the right direction and recent data continues to suggest robust growth in the fourth quarter.
Domestically the Australian trade balance deficit shrank more than forecast to the smallest gap since December 2014. The seasonally adjusted deficit decreased to -$1.227 billion with forecasts for -$1.7 billion, exports rose 2% and imports fell 1% with the predominant reason for the better than anticipated data coming from stronger commodity prices, particularly coal and iron ore. While an encouraging sign for the economy, the governments tax revenue, GDP growth and corporate profits it’s hard to get overly excited about the prospect of further gains in commodity prices.
Commodities have benefited from recent Chinese reforms to clean up their own domestic production as well as stimulus earlier in 2016 that has boosted the Chinese economy. However improving signs and further stabilisation of the Chinese economy is likely to keep further stimulus on hold while domestically in Australia we continue to increase supply with earlier lower prices not low enough for long enough to drive higher cost producers out of the market. That being said it’s also unlikely we will see prices fall back to their early 2016 troughs with iron ore bottoming around US$43 per tonne and coking coal around AU$78 per tonne compared with the current spot prices of US$65 and AU$265.
Locally the Australian dollar was +0.26% higher against the U.S. dollar and the ASX200 recovered the majority of early losses to finish relatively unchanged, down just -0.07% at 5,225.55. Meanwhile the market looks set to open lower this morning with ASX SPI200 futures down 25 points in overnight trading ahead of the release of the RBA’s quarterly statement on monetary policy and retail sales.
Data releases:
- RBA Statement on Monetary Policy (Q3) 11:30am AEDT
- Australian Retail Sales (MoM & QoQ Sep & Q3) 11:30am AEDT
- Euro-zone Markit Services & Composite PMI – Final (MoM Oct) 8:00pm AEDT
- Euro-zone Producer Price Index (MoM & YoY Sep) 9:00pm AEDT
- U.S. Unemployment, Non-farm Payrolls & Average Hourly Earnings (MoM Oct) 11:30pm AEDT
- Canadian unemployment Rate (MoM Oct) 11:30pm AEDT
Originally published by Rivkin Securities Pty Ltd.
