Market review: the falling pound, oil price concerns and interest rate outlook

Andrew Milligan

It’s been an eventful few weeks both domestically and globally. The UK has a new Prime Minister who has stated that his top priority is to deliver Brexit on 31 October, tensions are rising in the Middle East and President Trump has threatened new tariffs on Chinese trade. In his regular review, Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, looks at what this means for markets and investors. He also considers the outlook for interest rates.

The pound continues its downward trend

We continue to point to the pound against the US dollar or the euro to get a good idea about how investors are taking the increased talk around a no-deal Brexit. The current levels suggest that a lot of bad news has already been taken into account. But our analysis also suggests that it could go lower with more bad news about a no-deal Brexit or a hard Brexit.

What’s important to remember is that, while a fall in the pound isn’t welcome for many holidaymakers, it’s usually good news for UK stock markets. This is because many UK companies, particularly the larger ones, have substantial overseas operations. When they convert their overseas earnings back into sterling, they’ll see a rise in their profits.

Tensions with Iran continue

The UK has been drawn into the crisis with Iran, with the detention of a Syrian-bound Iranian oil tanker off Gibraltar, and the retaliatory seizure by Iran of a British-flagged tanker in the Strait of Hormuz. Some estimates are that close to 20% of the world’s oil supplies go through the Strait, so there’s concern about the potential impact on oil supplies and prices.

However, Saudi Arabia has oil reserves which would allow it to increase its supply quite quickly. And, by next year, new pipelines in the US will allow larger exports of shale oil. Because of all of this, we believe that oil prices will continue to trade in the range of $60-75 a barrel.

If oil prices do rise, in general terms that would be favourable for stock markets like the UK’s which have a high proportion of energy companies. There are implications for emerging markets too; for example it would be both positive for oil producers like Russia and negative for oil importers like India.

Interest rates are on their way down

The European Central Bank (ECB) has announced that it will cut interest rates in the autumn in an attempt to bring inflation back towards target, while the US has just announced the first cut in rates since 2008 – from 2.25% to 2%. This is a reflection of central banks responding to evidence of a serious recession in the manufacturing sector in most parts of the world. Global trade isn’t growing, and political uncertainty has dampened business investment.

The good news is that we believe a wider recession looks unlikely as service industries are far less affected. In addition, China looks likely to take further measures to stabilise the current economic slowdown.

The ECB has also hinted that there may be more quantitative easing (QE), as well as interest rate cuts. The combination of the two has meant that both European equities and European high-yield bonds have performed well in recent weeks. Changes in government spending levels and taxation would be preferable, but unfortunately political barriers make this look unlikely.

Other countries look like they’re following suit with rate cuts, including Australia and India. The UK remains an exception. Certainly the UK economy has slowed – growth will probably be flat year-on-year this summer. But inflation is close to target. So the governor of the Bank of England, Mark Carney, and his successor are likely to wait for any disruption caused by Brexit before making any rate cuts.

The longer-term impact of the US-China trade wars

Unfortunately the trade truce between US President Trump and China’s President Xi didn’t last long. Another round of tariffs on Chinese exports is threatened as recent talks have broken down.

According to the International Monetary Fund, the US-China trade conflict of the first part of this year has hurt China more than the US. In turn, the slowdown in China has had an effect on other economies, especially Europe and parts of Asia, which has had a knock-on impact on investor confidence.

For example, our analysis has shown some evidence of investors taking money out of emerging market equities. However, this is balanced by strong demand for emerging market bonds as a result of interest rate cuts in some of these countries.

Because many of Japan’s, Europe’s and the UK’s larger companies have substantial overseas operations, their stock markets have also been exposed to the Chinese downturn. This helps explain why they have generally not performed as well as US equities.

Looking ahead the key issue is how markets will respond to a combination of US-China trade tensions and the prospect of lower interest rates globally.

The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in.

Information is based on Aberdeen Standard Investments’ understanding in August 2019.