Oil volatile on tanker blasts, Sterling declines on Johnson's race to PM

Market Update

Equities finished the week strongly last week after selling off in the first few days. All regions were up slightly in local terms, however non-UK regions saw stronger returns in Sterling terms as the increasing likelihood of Boris Johnson winning the Conservative leadership election, and thus a hard Brexit, saw weakness in the currency, which was down -1.2% against the US Dollar. Emerging Markets lead the way, up +2.1%, with US and Japanese markets both experiencing significant returns of +1.7%. European markets gained +0.5% as the Euro was also affected, although to a lesser extent, by the leadership news, while UK equities gained +0.3%. Globally, oil and energy stocks sold off on news about explosions on oil tankers in the Strait of Hormuz, which could inflame tensions between the US and Iran. US Treasury yields were essentially unchanged over the week, while UK 10Y Gilt yields rose 3.4bps, with the return on Gilts -0.5% overall. Oil rallied strongly on the news of the blasts, although had already fallen significantly earlier in the week, so finished the week down -2.7%  in US Dollar terms.

CIO Analysis

Global risk assets have staged another comeback over the past few days, despite no progress on the US-China trade dispute. The catalyst, faithful to the mode of this entire 10 year plus cycle, was none other than the Fed. Following remarks from Jay Powell in early June that the Fed would support growth, and given evidence of slowing economic activity in the US, investors assumed that the Fed would completely reverse its previously hawkish strategy and start cutting rates. And, as always, when the Fed is dovish, traders are happy to buy opportunities at market dips. Therein lies the risk. Markets now expect three (!) rate cuts before the end of the year, i.e. cuts in all meetings September onwards. While the bond futures markets, from where those odds are derived, are hardly representative of the whole market, it is still indicative that maybe investor expectations have overshot reality. For three rate cuts to happen before year end the economy would have to be in freefall. Currently this is not the case. Manufacturing has somewhat slowed down, but employment is still very high, wage growth decent, consumption is hanging on, consumers and businesses are optimistic and the Fed is now projecting a 2% annualised growth rate for Q2, 0.5% higher than two weeks ago. This is hardly a picture of a recession. The next Fed meeting is on Wednesday the 19 June, and  Mr. Powell has to balance a more dovish message and at the same time bring rate expectations back to reality, without hurting growth or market exuberance. With the possibility of even the slightest word being misinterpreted, investors should be cautious in the weeks to come.

David Baker, CIO

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *