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Markets have continued to wrestle between a brighter outlook due to a release from COVID lockdown, versus a change in market leadership as the reflation theme (higher US house prices and consumer confidence, decent business surveys and a marginally better German Q4 GDP report from Europe) take hold. We are in a normalisation phase in the bond market after a collapse in yields during March 2020 – seeing bond yields back to where they were before the crisis, and this has tested the US Federal Reserve’s (FED) medium-term resolve on not raising rates. Equities have been consolidating recent gains after benefitting from months of rising earnings momentum and lingering suspicions that even more policy support would be forthcoming if necessary. Nothing has happened yet to derail the recovery and these periods of short-term volatility are perfectly normal.
This week, it was UK equities turn to be in the limelight after a continued sell off in US technology last week. The markets started brightly as housebuilders rallied as the news broke that Rishi Sunak’s budget on Wednesday would provide further support to the sector with a new mortgage guarantee for 95% mortgages and a continuation of the stamp duty holiday. These duly came to pass on Wednesday, as did the Chancellors expected introduction to how he will attempt to balance the books, or at least stop accruing further debt, in the years that come. He did touch on the effect on rising interest rates on the huge level of Government debt, simply put rising rates mean higher debt repayments for not just consumers, but the Government as well. Tax allowances will be frozen, but there will not yet be any actual tax rises for income, capital gains or inheritance tax, but there will also be no real increase in personal allowances in future years. One of the most eye-catching headlines was an increase in corporation tax for profitable companies from 19% to 25% in April 2023, but as UK elections will be looming, perhaps this is something that can be negotiated down nearer the time. Undoubtedly there is much to do to try and not only recover from the COVID pandemic, whilst still supporting struggling sectors such as tourism and hospitality, but also to start to balance future books should interest rates eventually start to rise. It seems for now that the Chancellor has a plan, the Bank of England have a plan, and they seem to have a lot in common.
Last week FED chairman Jerome Powell did his best to reassure investors that we are not at that point of the FED stepping away from supporting the market. He said that the US economy was still far short of meeting the FED’s objectives (full employment and an average inflation rate above 2.0%). But markets sometimes do not listen, and the message may need to be reiterated a few times. A similar story is playing out in the UK with the Bank of England disappointing many observers when it did not extend its own QE programme last month. The successful vaccine programme and Boris Johnson’s roadmap for opening the UK economy have led to a more positive view on UK growth, hence no further support at this time from the bank. In due course, I am sure the recovery will need further support as, just like in the US, the key macro indicators remain far short of where the authorities would like them to be.
Monetary policy (interest rates and the supply of money – as influenced by Quantitative Easing - QE) has been trying for years to stimulate economic growth, with diminishing power at ever lower levels of interest rates. QE has tended to push asset prices higher as it forced investors into risk assets as risk-free bonds became a negative real return asset. This benefits investors, but the impact on the actual economy is not so evident. Fiscal policy (taxation and Government spending) is more direct. It puts money in people’s pockets, it can be directed to buy goods and services and generate income flows. This is a real change in the previous policy environment. There has been a political shift in favour of fiscal policy (although not all politicians are in favour) and there is huge academic support for this. If the price is a 1% or so increase on the cost of borrowing, then maybe it is well worth it.
Policy makers have a role to play in more forcefully articulating the new policy world that we are in. The vision of the policy re-balancing is probably best articulated through action and we will see another big fiscal stimulus in the US and continued spending as the Biden Administration gets serious about climate change mitigation. Since 2008, the world has had a glut of savings. Governments are now tapping into those savings through increased deficits and borrowing. Central banks are not going to step away from supporting markets because they want to gradually smooth out the adjustment in long-term interest rates. Market commentators today are too short-term focussed and too hysterical about what are pretty modest moves in bond yields in the big scheme of things. Governments are utilising the global savings glut to provide a sustainable recovery from the pandemic and to make economies more resilient to additional “natural” risks like climate change. It happens at different paces – the US political system makes it imperative that the government acts quickly. In the Euro area, decision making is slower because of the need to get 27 sovereign states to agree on things. But it should happen and the recent appointment of Mario Draghi to lead Italy provides another strong voice pushing the agenda forward. With these changes in agenda, come new investment opportunities for us to research and implement on your behalf. As always, we remain focussed on this for you.