As the world tunes in to watch the ‘beautiful game’ showcased in Brazil, Islamist insurgents advance on Baghdad, the US navy deploys in the Persian Gulf, violence escalates in eastern Ukraine and riots against that association football tournament engulf Sao Paulo and Rio de Janeiro. Financial markets responded to the political disintegration in Iraq and upheaval elsewhere with a wobble, although global indices last week remained near to recent peaks and record highs. The whirlwind Sunni extremist uprising has caught the US administration and the international community off guard; just as the planet – and the World Cup 2014 viewing figures will warrant the hyperbole, with the record global audience of 4.7 billion in 2010 expected to be well and truly exceeded – communes to turn on, sit back and indulge in its most favoured spectator sport.
Despite the very real threat of a conflagration of conflict across the troubled Middle East, financial markets have remained preoccupied by economic growth and houses (or their dizzying prices). The good news is that 2014 increasingly looks like it will bring recovery at more than just a limp in the UK and America. However, the World Bank warned that the world economy will expand at 2.8% rather than by the 3.2% prediction it made at the start of the year, and it urged emerging markets to strengthen their economies before the US Federal Reserve raises interest rates. Meanwhile, the International Monetary Fund (IMF) sounded the alarm over the risk of a global housing market crash as prices rise well above their historical average and threaten global economic stability. House price inflation is not confined to the UK, where it rose by 11% over the past year; the IMF is concerned by the markets in Canada, Australia and New Zealand (and Belgium too).
The IMF also recommended that the Bank of England takes “targeted and timely” action to prevent a credit-fuelled housing bubble. Chancellor George Osborne last week acknowledged the threat, giving the nod to the Bank to cap mortgages; but it was the message from the Bank’s governor Mark Carney on the same Mansion House stage that dominated financial markets with his signal that the UK could become the first major economy to tighten monetary policy since the 2008 financial crisis. “There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced,” Carney declared. “It could happen sooner than markets currently expect.” Markets, which had widely anticipated a 2015 rise, were caught on the hop. Sterling hit a five-year high against the dollar, gilt yields climbed and property stock tumbled.
Carney’s response to UK economic growth places the Bank’s schedule for the rise of its base rate, for now, ahead of the US Federal Reserve’s expected interest rate policy. While Carney has found a more hawkish voice, his Fed counterpart Janet Yellen stressed that the US base rate will remain held for an extended period. The accommodative stance has ensured that Wall Street remains bullish that US equities can continue the recent record-breaking run. After it hit a record level of 1,956 points last Monday, the S&P 500 index dipped 0.8% over the week to 1,936 points amid the uncertainty over global growth and jump in crude oil prices. However, second-half growth for the US economy and earnings will give a further boost to equities.
In Tokyo, central bankers in Japan last week indicated that they would keep monetary policy steady and continue the annual ¥60–70 trillion asset-purchase programme. The Japanese government is also poised to relax constraints on its huge Government Pension Investment Fund, which is the world’s largest investment fund and worth $1.3 trillion. Japan is expected to lift the ceiling on equity holdings in August to around 20% from 12% at present, raising the prospect of a major boost for Japanese and worldwide stocks. Fund manager BlackRock believes this catalyst could drive Japanese stocks further. The Nikkei 225 Stock Average ended the week at 15,098 points, with the 0.1% advance over the five-day period its fourth successive weekly rise.
After European Central Bank (ECB) president Mario Draghi took a range of measures to head off deflation the other week, the euro fell by 0.7% over two days. Investors have interpreted Draghi’s hints that there is more to come to mean that the region is on the cusp of a move into a form of quantitative easing (QE). However, there has been disquiet in Germany over the implications of the ECB move for savers. The unease did not stop Germany’s Xetra DAX index pushing beyond the 10,000 mark for the first time at the start of the week; although subsequently over the five-day period it fell 0.8% to settle at 9,913 points. Fund manager Schroders notes that the DAX last month remained Europe’s strongest performer.
Follow The Fed
US equity markets remain buoyed by QE, although there is fear in some quarters that confidence on Wall Street has spilled over into hubris. But with valuations up on both sides of the Atlantic, there remains a need for corporate earnings, underpinned by a strengthening economy, to catch up. Global markets are less volatile than at any time in a decade as share prices remain near to or at record highs. The VIX index, which is Wall Street’s ‘fear gauge’, fell below 11 last week, which is half its long-term average and the lowest level since February 2007. Some have suggested that markets are in a calm before a storm. With QE now expected in Europe and the Japanese government indicating that it is prepared to continue its asset-purchasing programme, the era of loose monetary policy is far from over. And Wall Street remains bullish.
BlackRock’s global chief investment officer Russ Koesterich believes that the VIX shows that investors are complacent. “Eventually there will be a storm, but the VIX does not tell you anything about the timing of that storm,” says Koesterich. Fund manager Matt Cobon of Threadneedle Investments adds that the market seems to have bought “hook, line and sinker” that rates will remain low forever. “It feels as if we’re a few data points away from testing some of these underlying expectations,” adds Cobon. But low volatility reflects confidence in central bankers’ ability to protect markets against further shocks and crises. Markets believe policymakers can maintain economic stability and support asset prices. And, as Carney has indicated, central banks rather than markets or governments will decide when economies no longer need ultra-loose monetary policy.
Interest rates will dominate discussion at this week’s meeting of US central bankers, with markets expecting the Fed to retain the accommodative conditions that have kept market sentiment buoyant. The imperative for Yellen, as much as for Carney, is to keep economic growth on track and markets confident and keep inflation in line. The Fed next week is expected to maintain the current rate of reduction in QE, which would bring the monthly rate of asset purchases down to $35 billion and on course for an end to the purchases in October. However, the big question for the Fed remains not so much where to push the base rate in the short term, but where the base rate belongs over the coming years after it has started to rise.
Britain will watch keenly for its first base rate rise. Carney has insisted the increases will be gradual; markets have priced in a first rise in October and 1.5–1.75% by the end of 2015. There has been a focus on what this means for UK borrowers, but for savers the increases hold out little hope for cash deposits. Savers may take some respite in changes to ISA rules on 1 July that increase the allowance to £15,000 and end the restriction on the amount that can be deposited in cash. The changes also offer investors the opportunity to move in and out of cash in a Stocks and Shares ISA at times of volatility, and the new flexibility can give further peace of mind that their ISA portfolio reflects their appetite for risk.
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