Market and Economic Update
Thin summer markets can be volatile and last week was no exception. A temporary inversion of the US yield curve (2 year bond yields moving higher than 10 year bond yields); unnerved equity markets and triggered a series of lurid headlines about an imminent economic recession. Since 1945, each US recession has been preceded by such an inversion, with a time lag of between five and eight quarters from inversion to economic downturn. So why should this time be any different?
Recessions (and yield inversions) usually occur after a period of interest rate tightening by central banks. While the US Federal Reserve did raise interest rates on nine occasions this cycle, they have recently started to cut rates and are likely to do more this year. Meanwhile, the economy is in good shape. Employment is high, wages are growing and productivity is rising. The consumer represents 70% of GDP. None of this suggests that a US recession is imminent.
The main worries lie elsewhere. Germany posted a small decline in output for Q2 as did the UK. Tensions in Hong Kong are rising in a worrying fashion and Argentina looks as if it is heading for another default. Meanwhile, the trade dispute between the US and China drags on. Slower growth is pushing down bond yields globally as markets expect the usual response from central banks – more monetary stimulation. The US can do more, as can China, but Europe, with negative interest rates, is more constrained. Time for Germany to consign its balanced budget to the dustbin and start to borrow at zero cost to kick start the economy?
Elsewhere, the Brexit phoney war continued last week and we are not expecting too many concrete developments before Parliament returns in September. Jeremy Corbyn is understandably trying to drum up support for a temporary government led by himself as the only way to stop ‘no deal,’ but it is very hard to see that attracting enough support outside of his own party.
Looking ahead this week, we will hear plenty from the Fed and how they plan to respond to those recession fears as their annual Jackson Hole conference takes place. Markets currently see a rate cut on the 18th September as a done deal with an outside chance that it will be 0.5% not 0.25%.
Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.