In this week’s bulletin:
- Nuanced central bank edicts and hints of policy continue to drive equity markets
- The equity resurgence on Wall Street was led last week by the US banks
- The Bank of England is leaving its quantitative easing programme unchanged
- Japanese prime minister Shinzo Abe, following his weekend election victory, will continue his overhaul of the economy
Whispers in your sails!
The US Federal Reserve chairman spoke. Markets plotted the latest course of the beginning of the end of quantitative easing (QE) might take. Equity markets rose. And positive corporate earnings, particularly from the global banking sector, brought another week of rapid gains on Wall Street and the major global stock exchanges.
Nuanced central bank edicts and investors harnessing the slightest hint of future policy last week continued to drive markets. Fed chairman Ben Bernanke reiterated his tapering not tightening message. The Bank of England governor Mark Carney put a stop to talk of more QE. Equities continued to attract investors. And the major indices edged upwards.
Wall Street hit new highs last week after Bernanke’s words of reassurance before the US Congress that the $85 billion-a-month bond-purchase programme was not likely to end in the immediate future and was dependent on economic recovery. The S&P 500 delivered record intraday highs on strong second-quarter earnings, including from US bank Morgan Stanley, and better than expected unemployment figures. The index neared an unprecedented 1,700 level with its close on Friday at 1,692, up 0.2% from the previous day and 0.45% over the week.
In London, the FTSE 100 was up 1.31% last week, closing on Friday at 6,630; although this was down slightly by 0.1% on the previous day as net public sector borrowing statistics for the three months to June came in higher than expected. However, the FTSE 100 is up 15% since January and by 22% over the last year.
The FTSEurofirst 300 was up 1.1% over the week at 1,209. European financial markets also performed well, with some strong earnings from French banks. Meanwhile, Portugal’s president Anibal Cavaco Silva said he would keep his coalition in place to see the €78 billion bailout through to its scheduled conclusion next year, after talks with the opposition collapsed on Friday.
Japanese equities also rose as a weaker yen gave a boost to exporters, including shares in its automotive sector. After steady growth through the week, the Nikkei 225 Average declined slightly ahead of Japan’s elections at the weekend and Prime Minister Shinzo Abe’s victory. However, closing the week at 14,590, the Nikkei 225 is up an impressive 42% since 1 January, and a dramatic 72% over the last year.
Equities are booming. Bank of America Merrill Lynch reported that $19.7 billion was invested in global equity funds last week, which is the highest inflow for six months. The total now in US equity funds is the highest since June 2008. Equities are looking like winners in the Fed’s recent move to explain its intention to taper bond buying as employment figures strengthen. “A strong economy implies a positive outlook for corporate earnings and if recent history is any guide, share prices should perform well under these circumstances,” says Quilter Cheviot Investment Management.
Heat on Wall Street
The equity resurgence on Wall Street was led last week by the US banks. Morgan Stanley, Citigroup, JPMorgan Chase, Goldman Sachs and Bank of America together notched up second-quarter net profits of $17.6 billion. The S&P 500 gains last week reflected a return to the strength for the US banking titans.
Corporate America is looking increasingly like it is getting up on its feet – and beginning to run. The US banking sector is pulling clear of the financial crisis of 2007–2008. A healthy US banking sector means more lending for companies and consumers, both of which have reduced debt levels.
The recovery of the Wall Street banking giants coincides with improvements in the US economy. Equity markets are rising, the dollar has weakened and Treasury prices are rallying, as yields drop. US employment figures continue to look positive, with an average gain of 201,000 jobs a month so far this year.
The US budget deficit has also shrunk from 10% of the economy in 2009 to 4% for this fiscal year. Only recently the talk was of the US facing a debt crisis and higher interest rates. Rating agency Standard & Poor’s last month upgraded the US outlook to “stable” from “negative”, after stripping the world’s largest economy of its AAA credit status in 2011. Moody’s has also removed its negative outlook on the US’s credit rating.
Recent concerns are also easing over Fed plans to taper its bond-purchase programme and the further problems this could cause for the bond market. Investors are coming round to the idea that a reduction in bond buying as early as September is not a tightening of policy. Bernanke’s further statement along these lines last week acted as soothing balm for the US markets. The Fed’s stance and the improving US economy have made US equities appealing again. The S&P 500 has risen for four consecutive weeks, and has hit a record value of $15 trillion.
No more punch in the bowl and last orders at the bar. Depending on which side of the ocean the metaphor is drawn, the North Atlantic Anglosphere is preparing for a gradual reduction of QE. Meanwhile, the world remains in thrall of Bernanke’s statements. And it is listening, too, for signs of a transatlantic drift from the Canadian governor at the Bank of England.
Last week, the Bank signalled it would leave QE unchanged at £375 billion, putting pay to expectations of another round of QE funds. In the US, the Fed again stated that the slowdown of its $85 billion-a-month asset-purchase programme would start if the US economy continues to show signs of recovery.
Central bankers continue to drum home the message that the winding down of QE is not the end of loose monetary policy. In the UK, the Bank is looking at alternatives to QE to be launched as early as August, such as keeping rates low until 2016. The Fed stressed that its highly accommodative monetary policy would remain in place for the foreseeable future.
Markets are still talking about the Fed winding down its QE programme between September and sometime in mid-2014. However, Bernanke again emphasised that the asset purchases depended on economic developments. “They are by no means on a pre-set course,” he said. Carney and his colleagues at his first Monetary Policy Committee (MPC) moved away from QE. Two of the members, Paul Fisher and David Miles, had previously voted in favour of an extra £25 billion in QE funds.
Even if the Fed tapers towards ending its QE3 programme sometime in 2014, monetary policy is expected by many to remain loose. Europe and Japan’s central banks could continue to loosen policy to counter any side-effects of a Fed retreat from QE. And interest rates are set to remain low. The punchbowl is not empty; the bar remains open. However, there doesn’t look like much likelihood of a top-up or another round.
Follow the Fed
Carney won a quiet early victory last week when he persuaded Bank of England policy makers not to inject further easy money into the UK economy. The previous June meeting had included Sir Mervyn King who had supported expanding QE to support economic growth. The MPC seemed to have stepped into line with its counterpart on the other side of the Atlantic.
Sir Mervyn’s plan for another £25 billion of extra QE now looks like history. Consequently, sterling made gains following the Wednesday meeting. And the benchmark ten-year gilt rose as the prospect of the Bank making further asset purchases diminished. The Bank’s new governor is shifting monetary policy away from more QE. However, the MPC is considering alternatives. Carney is expected to instead make a commitment to keep interest rates low, possibly until 2016. Forward guidance statements are also expected to help keep sterling from growing much more in strength.
If Carney is to follow the Fed with guidance statements, he will need to look at what, if any, economic thresholds he will attach this to. He could choose a rate of unemployment below which the Bank would consider tightening policy, in line with counterparts in Washington. He could look at spending on UK goods and services, or nominal GDP, as a measure that could give a fuller picture of economic conditions. He could opt for wage growth or output gap figures.
This week brings Office for National Statistics figures indicating the strength of the UK economy in the second quarter. Surveys have shown that Britain’s recovery has been broad based, with improvements for retail sales, employment and construction. Britain is leading Europe in the number of new start-up businesses, according to the Organisation for Economic Co-operation and Development. The Ernst & Young Item Club expects 1.1% growth in 2013 and 2.2% next year. Improved growth could offer a fillip to UK-orientated equities.
The campaign for Sunday’s upper house election in Japan hinged on calls for the nation to make some painful structural reforms with the balm of tax breaks. Japanese prime minister Shinzo Abe, following his victory, pledged to renew his focus on overhauling Japan’s economy. The outcome will allow the Liberal Democratic Party to fire off its most important shot in the “three arrow” reforms.
Japan has been enjoying the propulsion offered by the stimulus package known as Abenomics unveiled in April. Fiscal stimulus and monetary policy are bringing much-needed growth to the world’s third-largest economy. The Bank of Japan is doubling its monetary base over the next two years to thwart deflation. This has sharply reduced the value of the yen, which has boosted export revenues.
Japan has enjoyed first-quarter annualised growth of more than 4%, together with an increase in industrial production. Abe’s policies of short-term spending and aggressive monetary easing have helped lift equities. Japanese stocks have rallied 42% this year.
However, Abe’s “third arrow” of structural reform is viewed as the bolt that will boost business and secure long-term economic growth. Japan is expected to slash corporation tax from its 40% rate to nearer an international average of 20–25%. Relaxing labour protection laws could also ease constraint on business. However, a proposed rise in sales tax to 8% from 5% could hit consumption and trigger a fiscal contraction.
A hard landing for the world’s second largest economy across the China Sea also poses big risks for Japan. China accounts for 20% of Japan’s exports – which is more than its trade with the US. A slowdown could trigger ‘risk-off’ sales of more risky positions, which in turn could hit the yen and damage Japanese exports.