Market View March 2018

Andrew Milligan

This month I take a look at how global markets are performing and what’s next for interest rates – in the UK and across the Atlantic. I also consider the outlook for Europe and the UK in the face of Brexit uncertainty and how the pound is performing.

Markets stabilise following volatility spike

Global stock markets have generally regained much of the ground lost in the sell-off at the end of January and the start of February. However, there are a few exceptions, such as the UK. It’s also important to highlight that the recent volatility spike was quite peculiar given it was limited to equities, with bonds and currencies little affected.

Looking forward there’s certainly debate about the outlook for stock markets. On the one hand there are concerns about company valuations, higher interest rates and political tensions. On the other hand, company profits are strong and analysts are upgrading estimates for future growth on the back of some very upbeat economic data. On balance, at Standard Life Investments we remain quite positive about global equities because of this.

What’s next for UK interest rates?

The Bank of England has indicated that the pace of interest rate increases could speed up if the economy remains on its current track. So the market is paying very close attention to the speeches and statements from Monetary Policy Committee (MPC) members.

Economic data clearly support some rate moves, as there are still upward pressures on inflation from generally tight labour markets. All things considered, the MPC is expected to move interest rates up twice this year, in May and November. Of course a variety of factors could cause the MPC to change its mind – currency volatility and Brexit are just two.

What does the Federal Reserve have planned?

As the Federal Reserve (the Fed) took no action to raise rates at its January meeting, the money markets have priced in an interest rate increase at the March meeting of the US central bank. Investors are looking further ahead, and debating whether there will be three or four rate moves this year.

On top of the underlying strength of the US economy, there’s considerable discussion about the full extent of the tax cuts and spending increases passed by the Trump Administration and Congress in recent weeks. With that in mind, economists are busy raising their forecasts for economic growth in the US in 2018 and 2019 towards 2.75%, even 3%. That will keep the US bond market under pressure.

With these prospects of stronger US growth in mind, we now expect up to eight hikes over the next two years, around double the pace currently priced into markets. This will be quite different to the more gradual adjustment still anticipated in other developed markets, such as the Eurozone and Japan. Currency volatility could be one consequence.

The pound’s recovery

I’ve recently been asked if the pound’s continued recovery shows resilience in the face of Brexit uncertainty. The truth is it’s a very difficult question to answer. Currency markets can be quite fickle.

Sometimes they’re focused on economic fundamentals, for example whether the UK economy is strong enough to encourage the Bank of England to curb inflation by raising interest rates. But other times currency markets are more focused on politics, whether that’s government issues in general or more specific issues like Brexit. On balance we are slightly underweight sterling in our funds.

Brexit and the outlook on Europe

Despite complex Brexit negotiations and the UK’s upcoming departure from the European Union (EU), there doesn’t appear to be a significant negative impact on Europe’s economic performance. The UK economy has certainly slowed since the Brexit referendum, for example there’s less demand for EU exports. But this has been more than offset by two other factors supporting the European economy.

One is the upturn in global trade and manufacturing activity in recent months – Germany benefits a lot from Chinese demand for example. The second is a virtuous circle; as unemployment comes down across Europe so consumer confidence and household spending start to rise. One of the reasons why many EU citizens recently living in the UK have returned home is because it’s easier to get a job there.

Looking ahead, our outlook for Europe is positive. The Eurozone upswing shows only minor signs of cooling in early 2018 and there are clear signs of strong growth leading to rapid job creation and lower unemployment. We remain quite positive about European equities as a consequence.

The information in this blog should not be regarded as financial advice. Please remember that the value of your investment can go down as well as up and may be worth less than you paid in. Information is based on our understanding in March 2018.