The Lowdown 19.06.2017

In this week’s issue:

  • This was a week for central bank announcements and less political rhetoric.
  • In the US the Federal Reserve Bank raised interest rates by a further quarter of a point.
  • The Fed provides more details about the unwinding of the US$4.5 trillion balance sheet.
  • Amazons purchase of Whole Foods for US$13.7 billion shakes up the global retail sector.
  • In the UK the Bank of England announces that there will be no interest rate change.
  • A week of little change in equity markets but the dollar slips and Treasuries rise.
“Global assets react to central bank announcements rather than politics”

This was a week for central bank announcements rather than political rhetoric, which in turn, moved markets and investor sentiment. In the US the Federal Reserve Bank announced a quarter point rate hike as expected, the second increase this year, whilst now believing that inflation will fall short of its 2.0 per cent target for this year.

In addition to this, the Fed did provide more details on how it is likely to unwind its US$4.5 trillion balance sheet, or portfolio of bonds which comprises of US Treasuries, mortgage-backed securities and government agency debt. This is likely to be done by letting the balance sheet slowly decline by not reinvesting the maturity assets.

This combination of raising interest rates for the second time this year and then gradually reducing its balance sheet equates to a tightening of monetary policy at a time when it would appear that the inflation rate is lower than was expected.

Therefore, the real takeaway story from this recent action from the Fed is that they have put in place a programme to start tapering their balance sheet, without putting any target date, and then raising interest rates carefully, given that they believe that the inflation rate will fall short of their target level which in reality means that they are very much on track to normalise both their balance sheet and interest rates.

"The Federal Reserve Bank believes that the US economic recovery is still on track"

Now in respect to the consumer, the Feds decision to raise its level for interest rates has had an immediate impact on other important lending rates such as the prime loan rate, and credit cards, which is likely to have an effect on house holding spending over the coming months. None-the-less, the Federal Reserve Bank believes that the US economic recovery is still on track, that labour market conditions are strengthening, and that their gradual adjustments in their stance for monetary policy is now untroublesome for the economy.

And in respect to US asset classes, the dollar weakened on the news from the Fed whilst US Treasury prices moved higher by the end of the week. Clearly, the bond markets are still grappling with the central bank’s monetary stance, and the direction for inflation. Unquestionably, there are still two camps of thought; firstly, there are those that support the inflationist view, whilst there are those that upkeep the deflationary story, and this battle between the two is likely to continue for a while longer.

Moving onto the US equity market, whilst the hike in interest rates was predictable, and therefore, most likely reflected in the market prior to Wednesdays announcement, it was the fall in technology stock prices and the news that Amazon was buying upmarket grocer Whole Foods for US$13.7 billion cash, or US$42.0 a share, that created the biggest response and downward pressure on Wall Street.

In respect to technology a renewed concern over the recent rise in stock prices, particularly those of the larger companies such as Facebook Amazon, Apple, Netflix and Alphabet sparked off some profit taking as investors began to worry about valuations within the wider sector.

"Amazon is looking to strengthen its presence in the US grocery business"

But perhaps the most intriguing event was that of Amazon buying Whole Foods given that this deal is likely to transform the retail sector. Clearly, Amazon is looking to strengthen its presence in the US grocery business, which is currently dominated by Wal-Mart Stores, but of course, this deal will give Amazon a significant boost in physical shops, given that up to now it has built a meaningful business online.

Also as we enter the world of Robotics, techie shopping could be something which develops over time, and the evolution of Amazon could include the check out free experience given that they are testing out a convenience store in Seattle that operates without check-out lines given that Amazon's Alexa robot maintains a shopping list.

The reaction within the retail market place to this deal saw share prices of the other supermarket chains fall, not only in the United States, but also in Europe, given that this is potentially a real game changer which could affect their business models and profitability.

Now moving on into the UK, understandably the affects rumbling on from the General Election and the hung parliament result continued to see the Conservatives and the Democratic Unionist Party continue to negotiate a manageable deal that will allow the Tories, under Prime Minister Theresa May, to continue in government but supported by them when required.

"The Bank of England, voted last week to keep interest rates unchanged"

Likewise, in respect to central bank policy in the UK, the Bank of England, voted last week to keep interest rates unchanged, but in a surprise move, the vote was much closer than in previous times. At the last count they voted 7-1 in favour of no change, this time the vote was much closer, 5-3 in favour of no change. Understandably, with the recent inflation rate coming in at a four-year high [2.9% on the headline rate and 2.6% on the core rate] it clearly affected some of the committee members views in respect to whether they should stay on hold or begin to raise rates to compensate against the continuation of rising inflationary pressures.

Equally, it must be said that since the European Union referendum the July year on year effect from the devaluation of sterling should begin to help stabilise these inflationary pressures, furthermore, with the political uncertainty to remain for some time it is quite possible that we might see some further weakness in sterling, however saying that, the pound looks relatively cheap and history has taught us that after severe devaluations the currency has recovered, perhaps three examples of this would be if you look at the sterling trade weighted index when the UK exited the ERM, the UK credit crisis, and indeed, after Brexit when it collapsed and then partially rebounded.

Clearly, the Bank of England, voted last week to keep interest rates unchanged, particularly the FTSE 100 Index given that over 70.0 per cent of their corporate earnings comes from overseas. But then again, a weak currency is bad for imports and those businesses that heavily rely on imported goods. Also the UK consumer is currently being affected by negative wage growth and higher inflation rates.

Elsewhere, it would appear that the Bank of Canada are becoming more hawkish on tightening their policy, whilst in Japan, the Bank of Japan have held their policy as unchanged. In Europe, the ECB are likely to reduce their asset purchase programme going into next year while the Peoples Republic of China are reigning in liquidity positions, money supply growth there is tailing off and market interest rates have been allowed to rise.

"The energy sector had a better week with Brent Crude Oil moving marginally higher"

And so to conclude with last week’s market changes, in the US retailers fell as they tried to digest the news that Amazon was to purchase Whole Foods, whilst in the UK the FTSE 100 Index had its worst week for two months amid political uncertainties and concerns about consumer spending. In Europe we saw gains in the financials, helped by a Greek debt deal, however, like on Wall Street European retailing stocks suffered. And lastly in Japan the market was rather lethargic whilst the yen fell on the news that the BoJ had kept monetary policy steady. On a more positive note the energy sector had a better week with Brent Crude Oil moving marginally higher, however, in precious metals the price of gold was down over the week.

Clearly, the economic recovery remains intact even though there are still political uncertainties and concerns about the possibility of a central bank error. Overall the bull case for shares is still in place and the background for holding real assets can be justified, therefore, we would be looking to take advantage of any equity market weakness that we might experience over the summer months.

Peter Lowman, Chief Investment Officer

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