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Quarterly investment commentary Q2 2017

August 7, 2017

Winners and losers swap places in a quarter of rapid change

Reversal of fortune was a theme of the second quarter, with growth in the Eurozone overhauling that in the UK and policy uncertainty in the US putting a question mark over the prospects for the world’s number-one economy.

The second quarter opened with a generally upbeat assessment of the world economy from the International Monetary Fund (IMF). At its Spring meeting in Washington in April, Maurice Obstfeld, the Fund’s chief economist, declared: “Consistently good economic news since summer 2016 is starting to add up to a brightening global outlook. The economic upswing that we have expected for some time seems to be materialising.”

But as US interest rates increased, the monetary policy gap between America and the rest of the world grew wider. The consequences of this divergence for global financial stability would become clearer in the months and years ahead.

What’s been happening in the UK

The big event in Britain was the shock General Election result on June 8. The widely-expected landslide for the ruling Conservative Party did not materialise and the party lost its majority, although remained in government. Both the FTSE 100 index and the FTSE 250, which is more reflective of domestic British business, displayed a relatively optimistic reaction to the hung Parliament – while both were down on the pre-election period, there was no crash of the sort seen after the inconclusive ballot of February 1974.

Sterling, already considerably lower on the June 23 referendum result last year, similarly proved resilient as the political landscape changed. While it no longer tested the psychologically-important $1.30 level, it remained well above $1.25 and showed no sign of returning to the lows of just above $1.20 seen after the referendum.

Growth in the UK was forecast by the IMF to slow from two per cent this year to 1.5 per cent next year, but these predictions were actually rosier, by 0.5 percentage points and 0.1 percentage points respectively, than the Fund had been forecasting in January.

But by the end of the second quarter, it was clear that real earnings – which had been growing from 2014 after five years of decline – were falling once again, with inflation of 2.7 per cent a year eclipsing average pay rises of 1.7 per cent excluding bonuses and 2.1 per cent with bonuses taken into account.

However, employment remained strong, with a 4.6 per cent joblessness rate that was the joint lowest since 1975.

What’s been happening in Europe

European capitals were relieved when France elected what was seen as a pro-European moderate to the presidency, Emmanuel Macron, in preference to the National Front leader Marine Le Pen. Coming after Mark Rutte’s victory in the Netherlands in the first quarter, it was seen as stemming the populist tide that had swept Britain’s David Cameron and Italy’s Matteo Renzi from office the previous year. And it coincided with a brighter economic outlook in the 19-nation euro-zone.

The IMF in April pencilled in 1.7 per cent expansion this year and 1.6 per cent next year, respectively 0.1 percentage points higher and no change on the January forecasts. Better still, it was looking for some easing of the euro-zone’s unemployment crisis, with a decline in the jobless rate from ten per cent in 2016 to 9.1 per cent in 2018.

What’s been happening in the United States

While President Donald Trump faced inquiries into the sacking of James Comey as director of the Federal Bureau of Investigation, the big economic story was the continued tightening of US monetary policy. For the third time since December, the central bank, the Federal Reserve Board, raised its key rate at its June meeting, this time from a range of 0.75 per cent to one per cent to a range of one per cent to 1.25 per cent.

Equally significantly, the Fed said later this year it would start to sell into the market the financial assets acquired through its quantitative easing programme, thought to total more than $4 trillion (£3.17 trillion).

While the Fed was reacting to strong economic numbers, especially for jobs, some feared it had not taken account of the likelihood that President Trump’s big-spending plans for defence and infrastructure may not get through Congress, thus removing a source of economic stimulus.

What’s been happening in Asia-Pacific

Japan presented a mixed picture during the second quarter. The world’s third-largest economy showed strong growth momentum but subdued consumer spending kept the lid on hopes that households could be decisively breaking with the fragile confidence of the past.
The reluctance of companies to increase wages is not helping, despite exports picking up on the back of strengthening overseas demand.

IMF April growth forecasts of 1.2 per cent this year and 0.6 per cent next year may not seem much to write home about but they are respectively 0.4 and 0.1 percentage points high than the IMF was looking for in January.

Elsewhere in the region, the IMF was forecasting average growth this year of five per cent and 5.2 per cent next year for Indonesia, Malaysia, the Philippines, Thailand and Vietnam.

Emerging markets

Russia earned some welcome praise from the IMF in May: “The economy is exiting a two-year recession that, thanks to the authorities’ effective policy response and the existence of robust buffers, proved shallower than past downturns. Growth is expected to reach 1.4 per cent this year, supported by easier financial conditions and higher oil prices.”

India, by contrast, saw its recent economic superstar status fade somewhat after growth slowed to 7.1 per cent in the year to the end of March from 8 per cent in the same period of 2015-2016.
In China, concern about high levels of corporate and household borrowing persuaded Moody’s, the credit rating agency, to downgrade the country’s debt.

Commodity prices

Oil prices moved back and forth in line with markets’ view of the ability of the 14-nation Organisation of Petroleum Exporting Countries (OPEC) to persuade its members to observe limits on output. Brent crude traded in a range of about $45 to $56 a barrel, ending the quarter towards the bottom end. The cash prices of copper barely moved during the quarter, opening at about $5,700 a tonne and ending at about $5,773. Coffee took a tumble, from about 140 US cents a pound at the start of the quarter to about 122 US cents by the end. Maize traded sideways, hugging a price of 355 US cents a bushel.

Outlook for the third quarter

Attention will be focused on three separate developments in Europe during the third quarter. These are the progress or otherwise of the UK’s Brexit negotiations, the success or failure of President Macron’s attempts to reform the French economy and Italy’s handling of its banking sector’s deep-seated problems. In the US, monetary tightening will vie for the spotlight with President Trump’s relations with Congress, not least legislators in his own party. In emerging markets, the slowdown in India and the debt worries surrounding China will continue to command attention. Globally, the hope will be that the upswing spotted by the IMF proves to have sustainable momentum.