Monthly Market Outlook May/June 2019Monthly Market Outlook Article
A combination of weak US manufacturing data and the ongoing trade disputes has resulted in a shift in investors' expectations for interest rates in the US, with the market now pricing in two to three rate cuts by the end of the year. Powell has said that the Federal Reserve (Fed) will "act as appropriate to sustain the expansion", implying that rate cuts are being seriously considered. A move towards monetary easing in the coming months would be particularly noteworthy, given that, until recently, the Fed had been proceeding with a series of interest rate rises and quantitative tightening to normalise policy, in the hope that it would have more breathing room to tackle the next downturn. This dramatic U-turn has led to a sharp decline in bond yields.
Unpredictable trade policy has impacted global supply chains and real economic activity. Trade talks between the US and China have been protracted, with both sides continuing to blame each other for failing to reach a resolution. The US President vowed to escalate the scope of tariffs whilst continuing to target the embroiled Chinese tech firm, Huawei. China retaliated by threatening to cut off the supply of rare earth elements exports to the US. Trump also took the immigration "crisis" further by threatening tariffs on Mexico for failing to curb immigration; he hinted at possibly withdrawing the exemption that remains in place for India, and is still considering levies on auto imports from the European Union (EU) and Japan. These developments were not positively received by equity markets. However, when Mexico conceded, the threat was removed and equity markets recovered.
In the UK, the shifting debate and deadline for leaving the EU is making the trajectory of the UK economy particularly tricky to forecast. The first quarter of this year saw surprising strength in the manufacturing sector, contributing to stronger than expected economic growth. This month, industrial production fell sharply confirming that the strength in the first quarter was due to companies building up inventories, anticipating that the UK would leave the EU in March without a deal. As inventories unwind, production may fall further. The speed and scale of inventory changes will continue to distort the data, making reading the economy particularly challenging. Mark Carney has described the current situation as the 'fog of Brexit'. It is unlikely to clear any time soon.
The Conservative leadership contest is now underway with Boris Johnson emerging as favourite to be Britain’s next prime minister. It is hard for us to see how a change in leadership will alter the numbers in Parliament. Members of the Monetary Policy Committee (MPC) have indicated that rates may rise sooner than markets are pricing in. However, the MPC is basing its predictions on an orderly exit from the EU, which is far from certain. Regardless, the UK stock market is doing well with a high proportion of overseas earnings, making it less susceptible to UK economic swings.
Last month the European elections took place. While it should have been an opportunity to debate Europe-wide issues, it was much more about local politics. Fragmentation will come to define the new European Parliament, which is likely to make it more difficult to pass new laws. Given that some Eurozone countries have been flirting with recession, the European Central Bank's (ECB) forward guidance has shifted to indicate that interest rates will not be raised until the second half of next year, and have also suggested that they may cut rates further, if need be.
As far as markets are concerned, global trade remains the real issue. Investors worried about the lack of progress with the US-China trade talks will be keenly watching the upcoming G-20 meeting. It is interesting to note that, despite all of this, US equity markets are close to their all-time highs