Central Banks back in focus

The Federal Reserve increased interest rates at the end of their 2-day meeting on Wednesday evening as expected. They did this in the face of yet more weaker than expected economic data from the world’s largest economy.  Core inflation came in below forecasts as did retail sales and business inventories. Growth in average annual real wages slowed, to 0.6%. The reaction of the bond market was worth noting as the yield curve continues to flatten. The yield difference between the 2 and 10 year US Treasury is now just 80 basis points, having started the year at 125 basis points. The bond market continues to paint a different picture to the one the equity market does. However, at 2.12% yields on the ten-year treasury look far more attractive than the equivalent British gilt or German Bund.

 In justifying this decision Janet Yellen focussed on the global economy and believes the US economy is “more resilient” than they realised over the past few years. The data coming from the US economy may have slowed recently however Chinese and European growth remains resilient. This could be where the Federal Reserve get their confidence that the US economy will start to rebound again. Underlying this view, the IMF increased their expectations for Chinese economic growth in 2017 from 6.6% to 6.7%. The Peoples Bank of China did not follow the Federal Reserve on this occasion and tighten their monetary policy as they did in March.

Not unsurprisingly The Bank of England left interest rates where they are, what did take the market by surprise was the vote which was much closer than expected for a rate hike. The vote was 5 to 3 in favour of keeping rates where they are. Equities in London fell partly as the pound fell, partly on concerns that the Bank of England might follow the Fed.

We sound like a broken record but this vote today just underlines how Mark Carney over reacted last summer. The much closer vote was probably in response to the latest inflation rate coming in at 2.9%. However, we believe the likelihood is that this could be the peak for inflation for the UK economy in the near term. Commodity prices have been falling, retail sales data has recently weakened. On top of that house prices are weakening and wage growth is low. Sterling has recovered from its lows, therefore the impact of weaker sterling will also fade. The current yield on ten year gilts would also suggest a similar conclusion.

Posted on June 15, 2017 .