Weekly Market Update – 19 August 2019

UK INFLATION

Down, not up

The July estimate from the Office for National Statistics (ONS) estimates a year-on-year increase of 2.1% for the Consumer Price Index. That compares with 2.0% in June and is, more or less, in line with the Bank of England’s target. Core inflation, which excludes the more volatile items of every day purchase like petrol, pale ale and apple pie, comes in at the more relaxed rate of 1.9%.

In the event, upward pressure on prices was most apparent in costs associated with recreation and culture (computer games, for example) while downward pressure was apparent in transport service costs.
Meanwhile, the pound is off around 4.3% compared with the dollar over the last twelve months or so. At those levels, we expect only a minor impact on inflation overall but perhaps there are steeper falls to come. The pound is down closer to 9.0% in the last six months and if
that were to remain in place, we might see a larger influence in another six months when it begins to influence the year-on-year numbers. Mind you, given a trend toward lower inflation almost everywhere, sterling’s weak exchange rate might manifest itself in a slower decline in UK inflation rather than a more explicit increase. Who knows, we’ll see in the fullness of time.

We’re less equivocal on rates, mind. I’m willing to bet that talk of an increase in Bank Rate from the Bank of England will turn out to be little more than talk. The next move is very likely down.

EURO ZONE BOND YIELDS

Lower and lower

Brace yourself. The governor of the Bank of Finland, a vote-carrying member of the Governing Council at the European Central Bank (ECB), has presaged a ‘significant and impactful policy package in September’. That brings to mind Mario Draghi’s ‘big bazooka’ back in 2014. The problem is, of course, that once you stun everyone with your big bazooka, you risk egg on your face if, the next time round, you don’t pull out something like an Exocet. And so, speculation is rife. Nudging rates further into negative territory won’t do it. Nor will more cheap loans for banks. Further bond purchases might. Buying a broader range of assets might. All of those together though; that probably would do it. We think there’s a good chance euro zone bond yields are headed lower. And lower. And then lower some more.

USA BOND YIELDS

Quite possibly, but probably not

Following last week’s brief inversion of the 10-year-2-year bond spread, we’re at least open to the idea that the US economy might be headed for (or may even already be in) a recession. We just
don’t think it is. The New York Fed’s model, based on the yield curve, puts the chance of a recession during the next 12 months at 31%. The Wall St Journal’s poll of economists puts the same chance at 34% on average with individual answers varying between 10% and 65%. Either way, we’re not about to panic. we’re diversified, we’re ready. Beyond that, the last two recessions were precipitated by enormous financial bubbles, making the subsequent downturn deep and long. We just don’t see the same extremes of risk today.