Investors remain gloomy despite a little sunshine

The UK economy grew at 0.5% in the third quarter, according to a release from the Office of National Statistics on Thursday. In July, economic forecasters were predicting the economy to shrink in the third quarter by 0.1%. The UK economy appears to continue to defy those who believed economic growth would fall off a cliff post the Brexit vote. Economic forecasts often hardly appear worth the paper they are written on.  Annualised GDP growth for the UK economy stands at 2.3% ahead of expectations of 2.1%. This is markedly ahead of the Eurozone predicted growth rate this year of nearer to 1.5%, and pretty much in line with the US economy.

So far, the more robust economic data coming out from the UK economy has had little impact on the currency, apart from arresting further weakness. Some people will question whether the fall in sterling has been overdone, as the economic data improves. Yet one does not get the impression many believe so, that’s one good reason not to discount the possibility.

The UK gilt market is a different story as the yield curve has steepened quite noticeably in the past weeks. Yields on ten year gilts, which at one stage, a few months ago, had fallen below 0.5%, now stand at 1.23%. Gilts are not the only bonds whose prices are moving higher, bund and US treasury yields are also rising to multi monthly highs. Later on Friday we get third quarter GDP estimates for the US economy. On Wednesday, ahead of the GDP release, the October flash Markit composite Purchasing Managers Survey index reading came in at 54.9, its highest reading since November last year.

The economic picture appears to be improving around the globe, and the current earnings season may end up showing year on year earnings growing for this quarter. Despite this positive backdrop investors remain cautious of the equity market. The latest Merrill Lynch fund manager survey reports that money managers hold nearly 6% of the fund in cash, this figure can fall as low as 3.5% during more optimistic times.

Equity investors have generally been bearish for most of this stock market ride, having little conviction in the rally. Bad news is often believed to be good news for equity investors as it prompts central banks into more simulative measures. This has certainly been the case over the past few years, pushing interest rates to lows not seen in anyone’s current life time.

Should economic growth continue to pick up, how will central bankers and capital markets react? Part of the answer to the question will be how much inflation accompanies any economic recovery. Should global economic growth continue to show signs of improving, alongside modest inflation expectations, this should allow central banks to take the foot off the gas slowly. A sharp uptick in inflation expectations could see central bankers react more quickly, this would lead to a selloff in the bond market that could well spill over into other asset classes. 

Posted on October 27, 2016 .