UK & US Economic Update – 15 December 2014

A shoddy performance from developed market equities as risk returns to the table

Dominating the week was a return to the headlines for Greece, with the nation’s Prime Minister forcing a Presidential election two months early in the face of a ruling by European finance ministers that the country has not done enough to secure the final tranche of bailout funds. A final tranche which will have enabled it to exit the contentious bailout program.

Instead the Greek government is now in a position where it is forced to ram through another round of austerity measures ahead of festive holidays. The news was immediately met by protests in Athens and was the key catalyst behind market unease throughout the week.

This of course led to a certain degree of upheaval and uncertainty across markets, with most indices closing the week at least 3% lower. The FTSE 100 lost close to 6% over the period while the Dow Jones in the US closed down 3.5%. European markets were a mixed bag with the CAC 40 in France down by 6.8% while the DAX in Germany capped losses at 4.7%.

In addition to political turmoil in Greece, demonstrations also gathered pace in Italy during week when thousands of protesters hit the streets once again in order to protest new laws which, among other things, strip away employment rights for workers. This underlines our view that political risk is a fast emerging, and significant, theme for investors in European equity markets

Lower oil prices and poor economic data from China were just some of a number of additional factors to have depressed equity markets throughout the week. This was as Brent crude fell to another five year low at $60.49 per barrel, dragging the oil majors with it, while both industrial production and inflation data from China came notably short of the mark.

Chinese inflation fell once more, down from 1.6% to 1.4% throughout November while industrial production also fell much further than expected, with actual expansion falling to 7.2% against a projected fall from 7.7% down to 7.6%.

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UK & US data remains relatively positive

The key piece of UK data due during the week was the belated manufacturing production number for October, which surprised to the downside; although more recent indicators continue to suggest full year growth is still tracking 3%.

US retail sales trumped all forecasts with core retail sales up 0.5% month on month, and overall retail sales up by 0.7% month on month. Weekly unemployment claims were also slightly lower than expected at 294K against a projection of 299K.

All in all, the UK and US appear to have escaped the worst of the economic malaise that is currently hanging over much of the developed and developing worlds.

Our view is that this is likely to continue as a theme into Q1 next year as many of the fiscal rebalancing measures required from the US economy are largely in effect already, while the UK’s policy independence has allowed it to defer a substantial portion of the tough love until after the general election in May next year.

Despite this, there are further risks to the outlook for equities in developed markets, particularly the UK and Europe, as we head into 2015.

In short, while there are also many reasons to believe that 2015 could be a positive year for portfolio returns in some regions, it remains to be seen whether or not portfolio returns will win the day over political and economic risk.

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Looking to the week ahead in the UK

The week ahead offers a heavily loaded calendar for UK economy watchers with stress test results for UK banks, followed by the Financial Stability Report from the FPC and the November inflation data early on Tuesday morning.

While stress tests will predominantly impact upon bank shares, the FPC Financial Stability Report (FSR) and inflation figures for November could have far reaching consequences for the months ahead.

On the one hand, lower inflation through November could lead to further weakness in both equity and sterling currency markets, followed by bullish moves in fixed income. While on the other hand the FSR provides a potential platform for Mark Carney to repeat once again many of his actions from recent weeks; talk up the pound by repeating his assertions that interest rates will rise even in the face of lower inflation.

On our part, we believe much of the bank governor’s actions of late are more of the same in terms of what we have seen before, in the form of policy makers attempting to keep market expectations well balanced.

This leads us to cite the governors past assurances that interest rates will remain low for an extended period throughout the economic upturn in late 2013 and early 2014, which were merely an attempt to to prevent expectations of an imminent tightening from becoming embedded.

In light of this, we view the governor’s recent statements as a similar attempt to keep interest rate expectations and market prices in balance. Just like before, when the bank made a concerted effort to prevent expectations of an imminent tightening,we believe that Carney’s current position that rates will rise even in the face of 1% inflation are merely a further attempt to prevent substantial swings in  in fixed income and currency markets.

To be clear, we do not believe assertions that rates will rise even with inflation at 1% provide an accurate reflection of the likely path of monetary policy.

While the UK monetary policy events could prompt some weakness in equity markets, we believe that the first round of presidential elections in Greece, on Wednesday, will be the key driver of equity markets for the week.

This is as a failure to agree on a candidate in Parliament would be expected to lead to the date for a second attempt being set, accompanied by increased unease among investors. On the other hand, a surprise agreement upon the right candidate could also lead to a relief rally, which may set the scene for a positive finish to December.

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Looking to the week ahead in the US

After several weeks of strong numbers emerging from US economic barometers, expectations for a rate rise from the Federal Reserve in 2015 are now becoming firmly embedded.

Given the recent performance of US equity markets in response to the data, US equity investors could be forgiven for wondering whether North American markets have now topped out after another strong year, where the Dow Jones has gained almost 9% on a peak to trough basis.

The week ahead sees the Federal Reserve release its quarterly economic projections report, where it is expected to raise to bank forecasts for US growth in 2014 and 2015. In addition to this, Janet Yellen will hold the December FOMC press conference following the announcement of the Federal Funds rate. CPI inflation and Core CPI inflation figures are also due during the period.

Our view is that the FOMC’s guidance on interest rates is likely to become slightly more hawkish at this conference, while we also see this being accompanied by an upward revision to current growth forecasts and some modestly adjusted statements referring to “diminishing slack” and “diminishing spare capacity”.

While the press conference could prompt some weakness in equity markets, we believe that the first round of presidential elections in Greece, on Wednesday, will be the key driver of equity markets for the week.

This is as a failure to agree on a candidate in Parliament would be expected to lead to the date for a second attempt being set, accompanied by increased unease among investors. On the other hand, a surprise agreement upon the right candidate could also lead to a relief rally, which may set the scene for a positive finish to December.

FTSE 100 // 10 Minute Intervals

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DOW JONES // 10 Minute Intervals

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