This week sees plenty of fundamental data releases which will make a welcome change from the political domination of the headlines seen over the last few weeks.
Purchasing managers’ indices are due from much of Europe and the US. Allied with US payroll numbers on Friday, these will influence market thinking with regard to the likelihood of an interest rate rise from the Federal Reserve on 14th December.
Average expectations are for 165,000 jobs having been created in November. Expectations for interest rates were broadly unanimous that Janet Yellen would hold off following the election of Donald Trump due to the added uncertainty.
However, now that the markets are focusing on the positives, expectations are now that it looks more likely that a rate rise will be sanctioned. Bearing in mind that the markets have tended to define Fed policy we would, therefore, anticipate a rate rise, especially as inflationary expectations are rising against the background of Trump’s spending plans.
Rate rise
A 25 basis point rise is not really going to make an awful lot of difference but it will serve to maintain the strength of the US Dollar. This works against the strength seen in oil prices and commodities more generally, although the global shift towards fiscal stimulation and away from monetary quantitative easing supports demand for commodities.
OPEC meets tomorrow to agree its production cuts but developments over the past week put this very much into question. Participants are arguing over the semantics of whether a freeze qualifies as a cut bearing in mind some would have put supply quotas up next year – this is Russia’s argument.
In addition, Iran, Iraq and Libya have pleaded poverty and demanded to be exempted from any cuts whilst Saudi has been quoted as saying that the market will achieve equilibrium on its own! If the meeting ends in no deal, this will be negative for the oil price as the last two months relative strength has been supported by hopes of some form of agreement. This will not help the equity markets.
Bond yields
Bond yields have continued their march upward, pricing in increasing inflation expectations. In the UK, import costs are rising everywhere whether it be flowers in Covent Garden, clothing sourced from overseas or fuel priced in dollars. This is, of course, a one-off effect of the fall in Sterling and, so far, retailers are taking much of the pain as current stocks and hedging facilities are creating a buffer to the end consumer and the CPI statistics.
It is an inevitability that inflation will rise but it is not necessarily a significant market negative. We have seen corporate activity in the markets with Softbank of Japan buying ARM Holdings and increasing speculation around others.
The uncertainty of Brexit is going to dissuade some investors from taking the plunge but as the fog clears over the next few months and years, we should see demand for attractive assets and a recovery in Sterling. Of course, as time ticks on with Brexit, the likelihood of our defaulting into the World Trade Organisation arrangements looks more likely and that would qualify as a Hard Brexit. The EU could force this outcome through stalling and intransigence. Let’s face it, the EU is hardly famed for its dynamic decision making!
Italian Referendum
Of more immediate focus is this Sunday’s Italian Referendum which is being heralded as a potentially seismic event. I would not bet against Renzi losing the vote as the tide of populism spreads.
Both the UK and US have enjoyed relative prosperity compared to Europe, with significantly lower levels of immigration and unemployment and stronger economic growth. European voters have every reason to take up the baton from Trump supporters and throw caution to the wind.
In France, presidential hopeful Francois Fillon has already set out a reformist agenda in recognition of the appetite for change from French voters. However, this is exactly what both Francois Hollande and Matteo Renzi attempted to do. Fine in theory but when the people have to take the pain, nobody wants it.
Diversification
As we have said before, diversification in these uncertain times is vital with markets in a constant state of flux. Predicting the winners for 2017 is especially difficult.
On balance, fixed interest looks like it will suffer as interest rates and inflation rise. Equities yielding 3.7% in the UK look relatively attractive but with likely volatility whilst commercial property demand has to be suspect as corporate investment will suffer in an environment of uncertainty. Perhaps the biggest risk is a US inspired trade war with China and the same involving the UK and the EU.
2017 could be a year where the world begins to go backwards globally and enters a new phase of protectionist trade wars where the strongest fare much better than the weakest.
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