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Commentary and Updates from Friends First Chief Economist Jim Power
As we approach the end of the first quarter, it is clear that it was a challenging three months on many fronts for investors.
On the geo-political front, the terrorist bombings in Brussels demonstrated clearly the ease with which the power centre of the EU was brought to a standstill. One can only surmise that this will be the nature of things for the foreseeable future, and further attacks could happen at any time in any place. It is difficult to quantify the economic and market effects of such events, but clearly they will inevitably generate fear and uncertainty from time to time. It is very difficult for investors to legislate for such risk, but the potential for such attacks is not good for economic and market sentiment.
The other big geo-political issue during the first quarter was Brexit. The referendum will be held on June 23rd and its outcome is becoming increasingly uncertain. There has been a strong business consensus to date that the UK should stay in the EU but that consensus is now being challenged. A group of 250 business leaders has just been formed to push the case for exit, with some interesting names, including companies who have invested in other EU countries, including the Chairman of JD Wetherspoons. The ongoing migration crisis and the inability of the EU to cope with it in a decisive manner and the terrorist attacks in Paris and Brussels will feed into the hands of the NO side. In the short-term, an EU exit would pose a considerable economic and financial risk to the UK. The longer-term implications would likely be less serious as the UK economy would have to adjust. Since the first week of January, sterling has shed 7.2 per cent of its value against the euro. Ahead of the referendum, sterling’s fortunes look set to be tied closely to the likely referendum outcome. An increased possibility of exit would be likely to lean on sterling and vice-versa. For the UK itself, for the broader EU and of course for Ireland, the June 23rd vote poses considerable risks and uncertainty.
On the economic front, the two key stories during the quarter concerned fears about the Chinese economy and persistent weakness in the Euro Zone. In the final quarter of 2015, Euro Zone growth expanded by just 0.3 per cent and by just 1.6 per cent on an annual basis. Furthermore, headline inflation in the area declined at an annual rate of 0.2 per cent in February. In summary, the Euro Zone continues to be characterized by weak growth and an ongoing failure of the ECB to satisfy its inflation mandate. Against this background, the ECB at its March meeting implemented further unprecedented monetary policy actions.
The ECB cut one of its key rates to zero (great news for those on tracker mortgages, and awful news for savers); it cut its deposit rate to a negative 0.4 per cent; it increased quantitative easing by €20 billion per month and increased the range of assets that can be bought as part of the quantitative easing process; and it introduced a measure whereby if the net lending of banks exceeds a stated benchmark, the interest rate on those operations could be as low as the deposit rate of negative 0.4 per cent. In other words, the ECB will pay banks to lend.
This ECB policy stance is utterly bizarre, but is deemed necessary as the ECB struggles to generate inflation and economic activity in the moribund Euro Zone economy.
In the US, the Federal Reserve Bank rowed back from its suggestion last December that rates would be increased on 4 occasions and by a combined 1 per cent during 2016. The latest suggestion is that rates will now rise by no more than 0.5 per cent. This softening in the tone of the Federal Reserve is reflecting the modest nature of US growth, and has eased market fears and has given some support to US equity markets in recent weeks.
In the year to date:
After a horrendous start to the year, all of these negatives are better than at the end of February, suggesting that the markets are becoming somewhat more comfortable again, particularly the US.
However, the markets will have to cope with considerable further geo-political and economic risk over the coming months, so investor caution looks set to remain the name of the game. Meanwhile, bond yields remain at extraordinarily low levels, with the German government now able to borrow for 10 years at just 0.15 per cent, and the Japanese are paying negative rates of 0.09 per cent.
We truly live in extraordinary times and this is not about to change.
(This publication is based on data available up to 9am March 29th 2016).