Much ado about little

Global equities were broadly flat in local currency terms last week for the second week running. However, the pound slipped back from its recent high against the dollar, leading to a small gain in sterling terms.

At a country level, the changes were muted other than in Japan and China. Japan lost 2%, leaving the market performing in sterling terms broadly in line with other markets year-to-date, despite all the excitement about the Nikkei index finally breaking above its 1989 high. Strong gains in local currency terms have been offset by renewed weakness in the yen.

As for China, this was up 4%. The improved performance of late has been down to the cheapness of the market and a feeling that pessimism over the economy had got overdone. This morning’s crop of numbers was encouraging in this respect with retail sales, industrial production and investment all rising more than expected in January/February.

Bonds have been choppy just recently. Last week, Treasuries and Gilts lost 1% or so, on the back of a 0.1-0.2% rise in longer dated yields, unwinding their gains the previous week.

The rise in yields was led by the US and followed slightly worse than expected consumer price numbers for February. Headline inflation edged higher to 3.2% from 3.1%, while the more important core rate slowed only slightly to 3.8%.

This was the second month running inflation has disappointed and is casting some doubt on whether the Fed will start cutting rates as soon as June. All will be revealed, or more likely not, at the Federal Reserve meeting on Wednesday.

The Fed is certain to leave rates unchanged and attention will be focused on its new economic projections and its verbal steer regarding the potential for cuts later this year. Most likely, it will stick with its December forecast for three 0.25% reductions by year-end, while continuing to emphasise that it needs to see more improvement on inflation before starting to ease.

While inflation is the most important factor for the Fed, there are other drivers too, notably growth. This looks to be slowing enough to allow the Fed to start easing over the summer but not enough to trigger aggressive cuts in a bid to head off a recession.

And then there are the elections in November. The Fed will wish to minimise the political fall-out from starting to cut rates, which might argue for a start over the summer, rather than the autumn just ahead of the election.

Although the Fed will be the highlight this week, the Bank of Japan meeting tomorrow is also a major focus. Here, the big question is whether the BOJ will take rates out of negative territory for the first time in eight years, albeit from -0.1% to all of zero or possibly +0.1%.

Now its 2% inflation target is looking much more attainable, the BOJ will over coming months undoubtedly raise rates, along with taking further steps to raise the ceiling on long-dated government bond yields. It’s more a question of whether they do so as soon as this week.

One issue here is what impact all this will have on the yen. The currency has remained surprisingly weak recently, even as the BOJ has started to tighten policy, but does look set to strengthen. It is super cheap and BOJ tightening later in the year will be occurring just as the Fed is easing.

Lastly, there is the meeting of the Bank of England on Thursday. Like the Fed, it too is all but guaranteed to keep rates on hold. Attention will be on any guidance on how soon rates will be cut and the voting pattern of the committee which was split last time – six members voted for no change, while two voted for a hike and one for a cut.

Most likely, the mantra from the BOE will be similar to that of the Fed and for that matter the ECB last week; rates will be cut but not before the summer. The latest labour market data showed regular wage growth slowing slightly further to 6.1% in January but remaining some way above the level consistent with the 2% inflation target. Wednesday’s consumer price numbers should paint a similar picture with headline and core inflation forecast to slow to 3.6% and 4.6% respectively.

Here in the UK, and also the Eurozone, there is considerably more pressure than in the US to cut rates to support growth, given both regions saw their economies dip into recession last year. Encouragingly, UK GDP increased 0.2% in January although this still left activity down 0.3% on a year earlier.

The prospect of rate cuts later this year has been an important factor supporting equities, even if expectations have been scaled back since the start of the year. Hopefully, this week’s Fed and BOE meetings will give no reason for these hopes to be trimmed any further.

Rupert Thompson – Chief Economist