Federal Reserve Cut Interest Rates
Market Overview August 2019
The US central bank took a new monetary policy path last month as members decided to reduce interest rates by 0.25% leaving a target range of 2 - 2.25%. Economists have suggested that this measure is prudent in light of projections that global growth is slowing down due to negative economic events such as the US-China trade war and the effect of Brexit on investor sentiment. Trade talks between the US and China continued albeit at a slow pace. Face to face meetings will take place this month and investors will be watching closely to attempt to garner an insight into how discussions are faring.
Brexit is at the forefront of all UK domestic policy. The election of Boris Johnson and the implementation of his Eurosceptic cabinet has raised the possibility that the UK could leave the European Union without a deal on 31st October.
In the space of six months the US central bank has U-turned from predicting that they would continue to raise interest rates throughout 2019 to making their first interest rate cut since the financial crisis in 2008. After raising rates last December, the Federal Reserve voted to lower interest rates citing weaknesses in global growth and commenting on the interconnectedness of the US economy to the rest of the world. The question for markets is whether the Federal Reserve could make a further cut towards the end of 2019. Lower interest rates are positive for corporates as they reduce the costs involved in servicing debt and encourage consumer spending. On balance, the slowdown of the global economy will have a knock-on effect on company earnings as general investor sentiment will weaken. Whilst the central bank continues to face pressure from President Trump to be more aggressive in their loosening of monetary policy, we believe that the Federal Reserve will attempt to hold onto its independence and focus on economic data when making their next decision on interest rates.
Despite the unexpectedly positive outcome from the US-China trade talks at the G20 meeting in June, the trade war is set to rumble on. The US is demanding effective monitoring and enforcement of Chinese promises, while China views implementing changes to its domestic law to allow this monitoring as an unacceptable infringement on its sovereignty. Moreover, despite the US relaxing some of the restrictions on Huawei, many in China view the imposition as proof that the US wants to limit China’s economic development. This will have a negative effect on global growth but the more important drivers are China’s fiscal and credit policy and the Federal Reserve’s monetary policy path. China has initiated a stimulus package, and we are yet to see the full effects feed through into activity. When they do, they should support growth not only in China but also in Europe, which relies heavily on Asia for external demand.
Sterling tumbled to its lowest level in two and half years in July, as markets became increasingly worried over the possibility of the UK crashing out of the European Union without a deal in three months’ time. Boris Johnson is ruffling feathers in UK and EU parliamentary circles by taking a position that the UK will either negotiate a new deal with the European Union or leave without a deal on 31st October. Downing Street has stated that our UK negotiating team would not meet EU leaders to discuss a revised deal unless they accepted two preconditions: that the withdrawal treaty be reopened, and the controversial Irish backstop scrapped. The European Union have reiterated on several occasions that the withdrawal agreement cannot be renegotiated and therefore we are heading for a stalemate. Key dates that we will be keeping a close eye on are the 24th August where the G7 leaders meet and there will be some direct interaction with influential names such as Angela Merkel and Emmanuel Macron. Parliament returns from its summer recess on 3rd September and if Boris Johnson’s initial negotiations have been blocked then MPs will quickly decide on their steps to take control of the Brexit process.
It is worth noting that the House of Commons is likely to be in session, after the summer recess, for about twenty-five days under the leadership of Boris Johnson. This does not give the Government much time to pass legislation for a potential new deal with the EU and the default position is for the UK to leave the European Union without a deal. As we have seen, Parliament has already voted against a ‘no deal’ Brexit and this stance is unlikely to change as we move closer to 31st October. If Parliament cannot come to an agreement, then it is probable that a general election will take place to attempt to elect a Leave or Remain coalition to break the Brexit impasse.
The President of the European Central Bank (ECB), Mario Draghi, has stated that more stimulus will be implemented if there are no improvements in the economic outlook of Europe. This was a surprise to some ECB policymakers, given that changes to bond purchases, interest rates and forward guidance policy were barely discussed in the update in June. There is likely to be some combination of renewed quantitative easing and rate cuts as the Eurozone is currently battling low inflation which could force the central bank to combat this through monetary policy measures.
The Eurozone’s economy grew by just 0.2% between the first and second quarter, confirming the region’s recovery slowed over the spring on the back of weaker global demand. The ECB is expected to unveil a package of measures, including rate cuts and possibly additional purchases of eurozone bonds, on 12th September to respond to the slowdown in growth.
China’s slowest GDP growth in nearly three decades highlights how the trade war has dampened the economy. Weaker economic growth has prompted the Chinese government to initiate a series of stimulus measures, as well as discussions around potential tax cuts. The breakdown in the US-China trade talks has reawakened the concerns we experienced in the final quarter of 2018 and this will continue until a deal is struck. We still believe that the most viable solution for growth in this area is for China to make an agreement with the US to remove the restrictive trade barriers and reopen opportunities for growth.
Macro events such as the breakdown in US-China talks, Brexit and the slowdown in Chinese growth are all influencing the direction of markets. The US-China talks continue to be protracted but we are hopeful that both world leaders will come to an amicable agreement to provide more certainty within the world economy. Despite the Federal Reserve dampening their outlook on domestic growth, the US is powering ahead when compared with other developed economies and we are still seeing business confidence improve which is supporting investment. The UK market will remain uncertain until the Brexit ambiguity has been resolved. The outlook for Europe is negative at present with Brexit uncertainty and US-China trade tensions being clear factors affecting this, which we believe will continue in the short term. We continue to favour fund managers that have a flexible, active approach, with a global remit, so they can asset allocate across the entire investment world (as we believe diversification is key). However, most importantly we will endeavour, on your behalf, to identify fund managers that invest in underleveraged companies with strong balance sheets as we believe that highly indebted companies will be punished, if there are any unexpected events.
Please note: The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 1st August 2019, and are subject to change. The update is for information purposes only. Source: Financial Times.