Market Update - November 2017
Central banks from the largest economies in the world have taken action to reduce monetary stimulus as the global economy continues to post positive indicators and inflation ticks up. The Bank of England have also hiked interest rates for the first time since 2007 as inflation rises and GDP figures were marginally healthier than predicted.
Central Bank Monetary Policy
The European Central Bank surprised investors and economic analysts by extending its stimulus programme until at least September next year, pushing down the euro as investors digested Mario Draghi’s refusal to call the end to emergency crisis-era measures. Despite the extension, the central bank still halved bond purchases from €60bn to €30bn starting from January next year. The ECB’s slow taper suggests the central bank will keep interest rates at their current record lows until 2019 — highlighting the gulf in the monetary policies between the eurozone and the US where the Federal Reserve has already started to raise rates.
As suggested, the US central bank already started their tightening of monetary policy by increasing interest rates back in December 2015. Since that increase there have been a further three interest rate hikes signalling that the US economy can cope with a higher interest rate policy. The US Economy has continued to perform strongly despite being negatively affected by the natural disasters that have occurred over the previous three months. These strong growth numbers, which were driven by increases in consumption and investment also highlight the likelihood of further interest rate hikes ahead by the Federal Reserve.
The Bank of England has increased interest rates for the first time in a decade, raising its benchmark by a quarter of a percentage point to 0.5 per cent and signalling the start of a gradual increase in borrowing costs. The first UK monetary tightening in a decade came despite forecasts for relatively weak economic performance. The Monetary Policy Committee now expects the UK economy to grow at about 1.7 per cent per annum during the next three years, well below the 2.5 per cent average seen since the second world war.
The European Union are naturally exhibiting a stubbornness to any suggestions of progress made in the Brexit talks. It is in the self-interest of the remaining 27 states to keep the Union stabilised by avoiding an advantageous deal with the UK. With the rise of populism, European leaders, do not want to give any inclination that a nation can leave the single market and still receive the benefits of being a European Union member. We are likely to see this ongoing tug of war between the UK Government who want to be perceived as the negotiators leading the debate and the European Union who aim to defend the principles of which the political and economic union was built on.
The European Union have stated that trade discussions cannot begin until a settlement has been reached for the commitments the UK made to the European Union budget. Theresa May has offered about €20bn of net transition payments but the EU wants almost triple that sum to cover Britain’s debts. This demand has caused a ‘deadlock’ in the negotiation discussions as the two parties must come to an agreement over the settlement bill. Until this monetary commitment has been finalised it unlikely that we will see any substantial progress in terms of trade talks.
Donald Trump is still looking for his first legislative win as President. Gary Cohn, the head of the White House national economic council, has suggested that the first victory will be in the form of tax reform which the administration will aim to push through later this year. This has been a keystone of Trump’s political and economic agenda and will test whether he will be able to achieve some of the mandate he was elected on.
The President has now given further details on his vision of US tax reforms. American companies would see their tax rate cut to below what many of their competing corporations pay elsewhere under a sweeping plan that aims to slash the corporate tax to 20% down from 35% and largely end the taxation of non-US earnings. For companies, the average top corporate tax rate worldwide is 22.5%. The proposed new US rate would come in below France’s 34%, Australia’s 30% and Japan’s 23% corporation tax rate. Gary Cohn is still adamant that the tax reforms can be pushed through by the end of the year. The Republicans have now cleared a hurdle in their efforts to overhaul the US tax code for the first time in a generation with a successful vote in Congress that opened the way for the introduction of reform legislation. In a landmark vote, the House of Representatives narrowly passed a crucial budget resolution from the Senate that is a prerequisite for President Donald Trump’s attempt to cut taxes and simplify the code. This is a positive indicator and indicates that perhaps Trump will be able to implement his historic tax reform
The President has now named the Federal Reserve Governor Jay Powell as his nominee to serve as the next chair of the Federal Reserve. The broad view is that the Mr Powell, who has been a governor on the Fed board since 2012, represents continuity from the era of Ben Bernanke and current chair Janet Yellen who is slowly unwinding the extraordinary stimulus the bank introduced after the financial crisis.
Yellen’s term will end on 3rd February next year where Powell will assume her role.
The Japanese Premier, Shinzo Abe, managed to win a thumping majority as his gamble of an early election was supported by the Japanese populous. A victory for the Liberal Democrat Party is likely to bring four more years of positive monetary policy; further liberations for education and women in the work place and a supportive Bank of Japan as the existing governor, Haruhiko Kuroda, is likely to be re-elected in April 2018.
The threat from North Korea seems to have calmed over the past month. This is mainly due to the lack of missile tests and therefore the threat has not been visible. Despite this, US Defence Secretary, General Mattis has stated that the nuclear threat is increasing and that any provocation would see a “massive military response” from the US. North Korea has always portrayed a threatening military brashness when interacting with any nation they believe is an enemy of their regime. The additional factor which now adds to the unpredictability of the situation is a US President who is also erratic in nature and is not afraid to use military might to defend national security. Despite these factors it seems suicidal for the North Korean regime to actively instigate a direct attack on the US or any surrounding nations. In the meantime, it is now up to China, North Korea’s most important ally, biggest trading partner and main source of food and energy to apply the necessary pressure on Kim Jong-Un’s regime.
Interest rate rises and the tightening of monetary policy suggests that the larger economies in the world are healthier. If Trump can push through his tax reforms then this will be beneficial for US corporations and of course US equities.