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As summer comes to an end and traders and politicians return to their desks, they will notice a significant change in the economic outlook compared to the beginning of the season. In June, Donald Trump had a seemingly unbeatable lead in the presidential polls. There was also uncertainty among market participants about whether the US Federal Reserve Bank would ever lower interest rates. Additionally, the dollar remained strong against the Japanese Yen, allowing traders to borrow cheaply in Tokyo and invest in big technology stocks. However, the situation has changed in September. Kamala Harris now has a lead in the polls and the dollar/yen carry trade has collapsed. Furthermore, ten months after stating that they would hold US interest rates at 5.5%, the Fed has explicitly stated that “it is time for policy easing”. Unlike the Bank of England, which is solely focused on controlling inflation, the Fed has a dual mandate of keeping both unemployment and inflation low. With US inflation now at target, the Fed needs to turn its attention to the employment data, which is slowly deteriorating. This means that the pace of interest rate cuts, will be determined not by inflation but by unemployment data. This cyclical shift historically signals the start of a new economic cycle for “Main Street.” Wall Street is already ahead of the game and it is encouraging to see, so far, modest gains for various asset classes, not just “Big Tech.” However, as always, volatility will be high at this early stage of the new cycle and investors should be wary of headlines predicting a “double-dip recession.” In the UK, despite being one of the fastest-growing G7 economies with lower debt levels than Japan, the USA, France, and Italy, the country is currently bogged down in economic pessimism with the dreaded “Austerity” suddenly back in Treasury fashion. The ongoing challenge for the UK is the expectation of European-style social services combined with low US-style taxation rates. Austerity was deemed an economic failure under the Cameron/Clegg/Osborne administration and while it is still early days for the current government, surely they will not repeat the same mistake, just as the economy is beginning to accelerate?
UK Green Shoots
The health of the UK economy is highly dependent on house prices, which are influenced by mortgage rates and unemployment levels. Since the Ukrainian invasion caused inflation, mortgage rates have significantly increased, reaching around 6% to 7% for variable rates. This level could have led to a high number of defaults and house repossessions. However, the post-Covid labour market remains tight, and companies have been reluctant to lay off employees. Additionally, existing fixed-rate mortgages have provided some protection for the market. Lenders have also been flexible in extending mortgage terms from 25 years to 30 or 35 years. Thus, whilst house prices have fallen, the impact has been mitigated. The Halifax House Price index declined as mortgage rates increased and the economy slowed in 2023. However, in recent months, both house prices and mortgage approvals have started to show upward trends. With the US Federal Reserve indicating lower interest rates, the Bank of England is likely to follow suit, especially considering the negative sentiment coming from the new government that could unsettle investor confidence. However, rumours of the Chancellor removing or restricting interest payments on commercial bank deposits at the Bank of England could have unintended consequences on bank lending, including mortgages. Nevertheless, there are presently green shoots emerging in the UK housing market.
US Leading Economic Indicator
A reliable indicator for US and global economic conditions is the US Conference Board’s Leading Economic Indicator. This chart shows that a negative rate of change has been a very accurate recession indicator. Although the US has not experienced a formal recession, there have been declines in US corporate earnings that resemble recession-like conditions. Interestingly, the rate of change has turned positive and appears to be on track to surpass the red recession signal line. However, markets remain cautious as they understand that recessions tend to occur when interest rates start to decline. Therefore, there is a risk that this indicator could reverse its upward trend and head back down, leading to a classic “Double Dip” recession. Market commentators are naturally pessimistic and are often quick to predict a “Double Dip,” meanwhile the optimists seize opportunities created by price weakness. This indicator is sensitive to interest rates and with the Federal Reserve signalling a decrease, the likelihood of further improvement is high.
Another key indicator is the price of copper, which is often referred to as “Dr. Copper” in the markets. The demand for copper is closely tied to the strength of the global economy as it is used in various industries such as artificial intelligence infrastructure, renewable energy, electric cars and housebuilding. These areas are forecasted to see higher than average demand in the upcoming cycle. Although the copper price experienced a boost from the recent AI boom, it has been unable to sustain those price levels due to weak global industrial demand. While the equity markets are reflecting optimism about a global industrial recovery, the price of copper is not confirming this sentiment, yet. China remains weak and is a big buyer of copper. For the long term, brokers point to a lack of new mines and the projected dramatic increase in electricity infrastructure needed to cope with demand.
Markets
The saying “Sell in May and go away, don’t come back until St Leger Day” suggests that investors should sell their stocks in May and not buy again until after the St Leger race which takes place on the 14th September. The adage seems to have worked to some extent so far in 2024. September and October are historically known to be challenging months for the markets and given the upcoming Presidential Election, this year is unlikely to be no different. However, on the 18th of September, the US Federal Reserve Bank is expected to announce the first in a series of rate cuts, but the question remains whether it will be a 0.25% or 0.5% reduction? To bring monetary policy back to a neutral level, the Fed would need to cut rates by 2.5% to 3.0%, which would require many 0.25% cuts. The decision will depend on factors such as unemployment and inflation data. Jay Powell, the chairman of the Fed, has been successful in staying ahead of the markets and would not want to find himself cutting rates in response to deteriorating unemployment data. Additionally, cutting rates in October is not politically feasible due to the election. Thus a 0.5% rate cut does seem like a possibility, although such a large initial cut might spook the markets. Investors may wonder what insights Powell possesses that they do not? It would require several weeks of careful communication from the Fed members to prepare the market for such a cut. Ultimately, the specific cut amount may not matter as the market follows the other old adage of “don’t fight the Fed” if interest rates are coming down, ultimately, markets are going up.
September 2024
