31st May 2017

Rathbones weekly review: A traumatic week

The week’s news was dominated by the suicide bombing at the Manchester Arena that killed 22 and wounded more than 100 people, many of them teenagers. The people of Manchester stood firm in the face of adversity, the police and security services uncovered a network of connections as far afield as Libyaand electioneering was put on hold. Markets were fairly calm, with the FTSE 100 up 1.1% and sterling weakening slightly.

Oil’s slippery slide

The markets seemed unimpressed with the deal reached by OPEC last week to extend production cuts into 2018. The aim was to prop up the oil price, but the 9-month extension was shorter than some had anticipated and the cuts not as deep as others had wanted. Brent Crude prices fell from about $54 per barrel to as low as $51.7 before recouping some of the drop. The effectiveness of shoring up prices by controlling output has been questioned by some who cite the US’s ability to ramp up their production of shale oil.

Source: FE Analytics, data sterling total return to 26 May

Still emerging, just more slowly

Emerging markets were also fairly calm amid news of a downgrade to China’s credit rating by Moody’s and a move by the ratings agency to put the outlook for Brazil’s sovereign debt on negative watch. China’s Shenzen A Share index fell from about 1940 to 1900 over the week, while Brazil’s Bovespa notched a small gain.

Moody’s downgraded China’s credit rating  to A1 from Aa3, the first downgrade for the major emerging market in nearly 30 years, the last following the Tiananmen Square massacre. Moody’s believes that the country’s financial strength will erode as growth slows and debt continues to rise. Years of credit-fuelled growth are presenting the Chinese government with the challenge of managing increased financial risks.

While many economists cite concerns over China’s ability to control its debt burden, now some 250% of the country’s gross domestic product, China’s slowdown has not been dramatic and appears to have stabilised. Meanwhile, the reform of state-owned enterprises is continuing at a slow pace, and China’s emphasis on stimulating its new consumer-focused economy is showing signs of success. Major Asian economies in general are improving, though at risk of potential protectionist policies from the new Trump administration.

While Moody’s left Brazil’s rating unchanged at Ba2, it lowered the country’s outlook to negative from stable, citing a fragile economy. The gloomier outlook followed another political scandal, this time involving bribery.

A cautious approach

The dollar dipped after minutes of May’s meeting of the US Federal Reserve (Fed) showed that policymakers are holding back on raising interest rates as they wait to see evidence that the US’s economic slowdown is temporary.

More interesting to some is that the Fed will discuss at its next meeting, in June, how to start winding down its $4.5 trillion portfolio of US Treasuries and mortgage-backed securities. To do this, the Fed is considering allowing a small amount of debt to retire each month without reinvesting the proceeds as it currently does. Despite the caution reflected in the minutes, many still expect a further two interest rate rises this year. 

The week ahead

Sterling weakness continues amid polls showing a shrinking lead for the Conservatives with less than two weeks left before the General Election on 8 June, and the pundits calling Monday’s TV ‘debate that wasn’t’ with Prime Minister Theresa May and Labour leader Jeremy Corbyn a draw. 

US non-farm payrolls on Friday will take centre stage in this week’s data line-up, with a flurry of key indicators also out on Thursday, including purchasing managers indices of manufacturing activity across the world’s major economies. Markets are looking fairly subdued in the meantime as more clues about the health of the US and global economies, and outcome of the UK election, are awaited.

Bonds

UK 10-Year yield @ 1.01%

US 10-Year yield @ 2.25%

Germany 10-Year yield @ 0.33%

Italy 10-Year yield @ 2.10%

Spain 10-Year yield @ 1.53% 

Julian Chillingworth
Chief Investment Officer

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