Financial Update from Brewin Dolphin - 14 July 2023

July 2023

The Weekly Round-up

Friday 14 July 2023

In his latest weekly round-up, Guy Foster, our chief Strategist, discusses slowing inflation in the US, Germany’s China strategy, and a rally in the yen.

It has been a generally good week for markets this week. The gains were led by developments in the US, although a weak dollar meant it wasn’t the strongest performing region. Paradoxically, a strong yen actually dampened returns from Japan.

The US

As ever, the market looks to the US for guidance with its steady flow of crucial economic indicators and regular earnings reports. This week marks the beginning of an interesting period for markets as the news flow ramps up (with three weeks of prolific earnings reports, jobs reports and interest rate decisions) at a time when liquidity declines as the holiday season begins.

A benign start to that period came this week with the June consumer price index (CPI) report. After a painful couple of years for inflation, this report was universally positive. For the first time since mid-2021, the monthly increase was consistent with the Federal Reserve hitting its 2% annual inflation target. Other measures of underlying inflationary pressures fell as well, adding to confidence that the current trend of moderation should continue.

The US producer price index for final demand rose only 0.1% from a year earlier, which also indicates cooler inflation. This news might provide some comfort to Federal Reserve officials, who have been closely monitoring inflation trends.

The news was greeted well by equity and bond markets, which see less risk of higher interest rates as a result. For the same reason the dollar gave up ground.

The House Republicans have threatened to block bills that lack sufficient spending cuts, raising the risk of a government shutdown later in the year. This political tension could have implications for economic stability and market sentiment.

Under these circumstances, would the Fed continue to raise interest rates? It probably should do. Additionally, fewer-than-expected people filed for state unemployment benefits, suggesting a resilient jobs market. Meanwhile, the US housing market continues to recover. Housing is one of the more interest rate-sensitive sectors of the economy.

As earnings season began, attention shifted to pricing and guidance. Concerns were raised that US consumers, faced with surging inflation, were trading down to cheaper options or going without altogether. China’s exports also continued to decline, adding to the economic challenges faced by the nation.

Geopolitics remains fractured

One of the momentous events of the week was Turkey’s agreement to support Sweden’s bid to join NATO. However, Turkey sought assurances regarding Swedish Kurdish separatists and, in return, president Recep Tayyip Erdoğan attempted to make the country’s endorsement dependent upon the granting of EU membership for Turkey. European officials agreed to expedite membership negotiations, but stopped short of tying the two matters together for obvious reasons. A factor potentially prompting Turkey’s acquiescence was the US Congress signalling that Turkey’s purchase of American fighter jets was contingent upon Sweden’s NATO membership ratification. While Hungary still needs to ratify Sweden’s membership, it is not expected to oppose it.

The implications of NATO expansion for global stability are difficult to weigh. For a long time, it was deemed helpful for a geographical buffer to exist between Russia and NATO members to avoid conflicts on Russia’s borders automatically triggering an article five mutual defence response and effectively putting Russia at war with NATO. Equally, however, this has allowed Russia, under president Vladimir Putin, to make incursions into that buffer zone, annexing territory without having to face a NATO response.

A NATO summit in Vilnius revealed tensions between Ukraine and its western backers over the pace and variety of resources being offered to support its turgid counter offensive. European members are struggling to source military hardware to donate, the US is now donating cluster munitions which are banned by most other western countries, and Ukraine has not yet gained access to the F-15 fighter jets it seeks to propel the advance.

China’s weakness is widely acknowledged

Still reeling from the painful process of reducing energy reliance on Russia, Germany announced its first China strategy to deal with its dependence on the increasingly authoritarian nation which has eclipsed the EU economically and has now been labelled an economic ‘rival’. A 64-page document describes measures to reduce dependence upon China for supply chains and export markets. The practical implications are less clear, with German business welcoming the balanced tone and the lack of material measures to curtail exports or investments.

Germany’s trade data this week was disappointingly weak. This likely reflects weakening global demand as much as domestic conditions or attempted geopolitical decoupling. Economic expectations for China have been revised lower following the disappointing rebound from the end of Covid-zero restrictions. But despite these low expectations, the economy continues to underwhelm.

This week saw more piecemeal action and discussion of economic support measures. Authorities extended loan relief for developers to bolster the property market. State-run newspapers hinted at additional property-supportive policies and measures to enhance business confidence. The China Securities Journal suggested that the government would accelerate policy roll-out to promote stable and healthy development in the real estate market. There were also talks of introducing measures to boost business confidence among private, state-owned, and foreign firms following recent meetings between officials and company executives.

China’s credit growth numbers for June did reveal an increase in monthly aggregate social financing, driven by renminbi loans to households and corporations. New yuan loans rose significantly, indicating potential growth in the housing market and increased investment demand. This robust credit expansion raised hopes that the People’s Bank of China’s easing actions were taking effect and could support China’s recovery in the second half of the year. Taken in the context of the last year, credit has contracted by some measures. China is also facing various economic challenges, including sluggish consumer spending, a shaky property market, declining exports, high youth unemployment, and local government debt.

The UK

The UK government announced an agreement between major pension providers to increase their investment in growth companies, potentially unlocking £50bn if the rest of the industry follows suit. Other measures to improve pension performance were also introduced, such as consolidating low-performing plans, doubling investments in private equity by local government pension funds, simplifying investor prospectuses, and creating an “intermittent trading venue” for private companies to access public markets.

While there were positive signs for the supply side of the UK economy, such as wage growth and a decrease in the misery index (the unemployment rate, which is low, added to the inflation rate, which is high), the Bank of England may not be able to relax. The tightness in labour markets appears to be easing, with a decline in vacancies across most sectors. However, employment growth remained healthy overall, and consumers were celebrating the moderation of inflation and robust wage growth by spending on seasonal summer goods. This should leave Bank of England maintaining a cautious stance and showing willing to flirt with economic recession in order to curtail inflationary forces.

The UK’s monthly GDP estimate for May was slightly negative, indicating that the economy was still struggling to surpass pre-pandemic levels. The economy lacked momentum, potentially impacted by factors such as extra bank holidays, strike actions, and a downturn in construction activity. These data may underestimate the current momentum in the economy, but there are looming headwinds to consider.

Japan

Moving to Wednesday, the yen experienced a seven-day rally, its longest in five years, which weighed on Japanese equities, particularly in local currency (or currency hedged) terms. FX hedged investors should consider taking profits because there is a bull case after a marked period of weakness.

With a fortnight to go until the Bank of Japan’s (BoJ) next policy meeting, there is growing speculation that it might use that opportunity to relax yield curve control. The latest to join in that speculation is former BoJ director Hideo Hayakawa, who said: “I expect they will make some kind of adjustment to yield curve control this month…if they don’t, it doesn’t make sense.”

Inflation has picked up markedly during 2023 and wage growth has risen at its fastest pace in almost 30 years. Together, these could form the self-reinforcing cycle of rising wages and prices that the Bank of Japan has been seeking, but it will depend upon the final results of the annual union Shunto wage negotiations.

Since taking on the governorship of the Bank of Japan, Kazuo Ueda has expressed positivity about the yield curve control’s impact on inflation, but has also stressed that the seven-year-old policy is not permanent and could be causing distortions. Yields are currently near the upper boundary of their current permitted range under the policy. The BoJ has been buying at a reasonably brisk pace in order to keep them there.

It’s possible that the central bank will want to see more evidence of entrenched inflation before relaxing the policy – particularly as recession risks remain. However, the current situation offers an opportune moment to relax the policy when speculative pressures might not force yields too high.

The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.