Central bankers and the markets
LAST Thursday, the Bank of England raised the base rate for the second time in this cycle. This move is not part of a smooth and persistent normalisation so far witnessed in the US. The UK's central bankers are engaged in a more protracted and stuttering reload of their monetary arsenal. The UK economy continues to make heavy weather of the favourable global backdrop. Self-inflicted uncertainty continues to deter investment and real wage gains remain substantially absent in spite of a fully employed workforce. In the short run, we should expect more of the same, particularly while the nature of the economy's exit from the EU remains hazy.
For investors, the reminder is again that capital markets, even those domiciled in the UK, are just not that interested in the fate of the UK economy. Sterling's spasms can certainly have an effect on portfolio returns from currency translations, but for the intrinsic worth of stocks and bonds, it's the US economy that matters most.
:: Federal Reserve
The booming US economy and its capital markets should continue to set the drumbeat for returns elsewhere. It's no exaggeration to say that the US Federal Reserve effectively set the stage for how other central banks around the world conduct their monetary policy. For the moment, the process of delicately untangling the economy from a decade of experimentation (quantitative easing) has proceeded without major hiccup.
This operation has been facilitated by a mostly benign economic setting; growth has remained strong, jobs continue to be generated, but inflationary pressure has remained substantially absent. That pressure is gathering a little on the evidence of last week's employment cost data, but still not to the extent that would panic central bankers or bond bulls.
Nonetheless, theory would argue that adding tariffs to imports and dumping a load of spending and tax cuts on an economy already operating at or around full employment should see aggregate prices rise in an economy.
Little flickers of action from the central banks of the UK and Japan, combined with a pass from the US Federal Reserve, may have given some the impression that the natural order of the last few years is starting to fracture – the rest of the world is finally joining the US in weaning their economies off the extreme monetary medicine of the post crisis era. This would be a misconception. The Bank of Japan seems to be simply bedding in for an even longer period of easy monetary policy than previously planned. Meanwhile, the Bank of England is probably now done until deep into next year. The market is probably rightly not expecting much out of the European Central Bank for at least 12 months, after firm guidance from President Draghi.
We have recently slightly reorganised our fixed income exposure to reflect tweaks to our expectations and the resulting assumption on valuations. We have moved the majority of our overweight position in junk bonds to our short-maturity bonds bucket. We give up some yield in our tactical portfolio, but gain some liquidity and a little bit more ballast. The overall character of the portfolio remains one that will benefit from continuing economic growth, thanks to its tilts towards developed and emerging market equities. However, this move does fractionally increase the resilience of the portfolio in the event of a less sunny outcome.
Jonathan Sloan (firstname.lastname@example.org) is a director, Barclays Wealth & Investments NI.