Last week we discussed at great length, both in this blog and on CNBC, that we have taken the view that the world will have to prepare for a gentle reduction in central bank’s stimulus, as we believe that the time of greatest liquidity is now behind us. We base this view on two factors, one the Fed will move to raise interest rates sometime next year and the ECB will not introduce US style quantitative easing. Our belief is that the global economic recovery will move from a liquidity driven one to a more sustainable earnings driven one.
Last week saw equity, bond and commodity investors lose as bond yields rose and equity markets fell. The recent rise in bond yields has been noticeable, but so far the impact on equities has been modest. 10-year US treasury yields have moved from a recent low of 2.3% to close on Friday at 2.62%. 10-year UK gilt yields also rose closing on Friday at 2.53%, this move was very much in line with US treasuries and not a reflection of pre Scottish vote jitters. Developed equities gave back just under 1% on the week. Sterling regained some of the recent lost ground to the US dollar at the end of the week closing at $1.63. The US dollar basket that has been gathering strength over the past weeks paused for breath ahead of the Federal Reserve's latest interest rate announcement on Wednesday. The expectation is that the Federal Reserve will drop the word "considerable time" from their policy statement, and Janet Yellen will confirm the completion of the bond-buying program in October at the press conference following the rate announcement.
The gold and oil price fell again last week, both continuing to be impacted by the stronger dollar and in the case of gold rising bond yields tarnished gold's lustre.
Equity investors appear to remain cautious, Equity volatility crept up as the Vix index closed the week at 13.3 points, just above the 50-day moving average. There was a similar spike in the bond volatility index. The weekly AAII report showed a small increase in bearish sentiment, as bullish sentiment came back in line with the historic average. Fund flows continue to show money moving into Investment grade bonds (38 straight weeks), and emerging market equities. Overall demand for Investment grade bonds continues to outstrip that of developed equities. It will be interesting to see if this pattern carries on in the event that bond yields continue to rise.
The Scottish referendum will be front and foremost of most newspaper articles again this week, as the voting date is Thursday. Whilst opinion polls continue to show the result in the balance, we firmly remain of the view the "no" campaign will win the day, but the relationship between Scotland and Westminster will be irrevocably changed post this referendum.
Other than the Scottish referendum, there is plenty of economic data to digest from all parts of the globe. Over the weekend China reported a weaker than expected year on year industrial production number coming in at 6.9% against expectations of 8.8%. In Europe on Tuesday sees the release of Germany’s economic sentiment index and on Wednesday inflation data. As is usual in the US, aside from Wednesday’s Fed meeting there is a constant supply of announcements offering further insights as to the strength of the recovery.
The Bank of England publishes the minutes from their last meeting on Wednesday, investors will be looking to see if more members have moved to the “interest rate rising” camp. Aside from the minutes on Wednesday, it’s also a busy week in the UK for economic data. Inflation data on Tuesday, where the year on year rate is expected to fall further to 1.5%, and on Wednesday we get the latest unemployment rate. Wednesday also sees the release of the latest hourly average earnings data. Any sign of a pick up in earnings will act as a lead indicator to the Bank that higher inflation rates could follow.