Janet Yellen’s Jackson Hole speech finally brought an end to the summer lull especially after she echoed recent comments by her Fed colleagues and suggested the next rate hike is getting close. In terms of timing, markets still see December as more likely than September but a move next month is now 36% priced in which is the most it has been for a while and this Friday’s nonfarm payrolls could be pretty crucial. The recent data out of the US has generally been quite supportive of a rate hike, especially last week’s durable goods report, where orders rose 1.5% in July ex-transport and was the first decent news on business investment for a few months.
Looking ahead, there is quite a lot of economic data released this week besides nonfarm payrolls, including the US ISM and consumer confidence surveys plus the Chinese manufacturing PMI. In the UK, the post-referendum data has held up very well so far but house prices, consumer confidence and manufacturing PMI’s are all out this week.
August has been another crazy month in the gilt market mainly due to the resumption of QE. There have been some outsize moves at the very long-end of the market where the Bank of England has had to pay over the market price in order to persuade holders such as pensions funds and insurance companies to give up their bonds. The index-linked gilt market, which has a duration of 23 and has a 70% weighting in over 15 year bonds, has returned almost 10% in August alone thanks to a combination of falling yields and rising inflation expectations – that contrasts to ‘only’ 2.9% for the conventional gilt index. Clearly a weaker pound and Brexit uncertainty means this could run on further, but the very long end of the market does look highly vulnerable to any bond-unfriendly news e.g. increased issuance or changes to pension regulations.
Although Monday was a bank holiday in the UK, the US stock market was open and had time to fully digest Janet Yellen’s speech at the Jackson Hole symposium last Friday. Shares, which had been soft in the run-up to the event, rallied, despite a slightly more hawkish view on the interest rate outlook from the Fed Chair. Financials led the rise, not surprisingly, given that the sector is probably a net beneficiary of higher interest rates. The stock market’s love / hate relationship with higher rates is all about the reasons and the magnitude. A strong economy is good for growth and jobs and shares. Rising interest rates are not uncommon in this environment. A modest tightening that does not choke off growth is additionally welcome. In other words, the US stock market will weather modest rises in rates as long as they don’t derail the economic recovery. No pressure then, Janet!
Here in the UK, we have monetary policy heading in the opposite direction, with the Bank of England desperate to prevent a sharp downturn that so far seems to have been largely illusory. Indeed, economically sensitive sectors such as housebuilders would be expected to reflect any change in mood very quickly. Not according to Persimmon, who last week reported good trading conditions post the referendum. Combine that with robust consumer spending and the UK economy does not seem to be about to fall over a precipice. Reflecting this, the more UK facing FTSE 250, the index of medium sized companies, has outperformed the larger, more international FTSE 100 over the last month. So far, so good. Early days, though, but to repeat what former governor of the Bank of England, Mervyn King, said in a recent interview, the only honest answer to the outlook for the UK in a post EU world is, “we don’t know”.