Reflation Week

At the end of May this weekly report mentioned it was a bad idea to get too bearish since a trade deal, a cut in interest rates and improving US productivity data, which was strong in the first quarter, were still possible.

This week we had good news on the first two points and markets have duly responded. Global equities are up some 2% on the week whilst the dollar is down. Bond yields are a little lower and measures of volatility are flat. The major movers of the week were once again gold, which rallied some 4%, and oil, which has risen over 6%.

The biggest news this week came from central banks on both sides of the Atlantic. On Tuesday Mario Draghi, President of the European Central Bank, said the ECB could launch a fresh expansion of its €2.6trn quantitative easing programme if the inflation outlook failed to improve. These comments caused the Euro to weaken, which in turn elicited some angry remarks from Trump, accusing Draghi of currency manipulation. Then on Wednesday Federal Reserve Chairman Powell did the most he could do to loosen monetary policy without actually cutting interest rates. Even Goldman Sachs, which previously had not been forecasting imminent rate cuts, had to capitulate and now expects cuts to US interest rates in July and September. Negative yielding debt, so debt where the interest rate is negative, jumped to a record $12.5trn and stock markets rallied hard.

On trade, things are looking a lot more positive and it now appears highly likely that presidents Trump and Xi will be meeting to discuss trade at the G20 meeting in Japan next week. On Tuesday Robert Lighthizer, the US trade representative, said that Washington was “ready to engage” with Beijing and he added that there was a shared goal to “resolve” the trade dispute. Trump is also coming under pressure at home and this week the most powerful business group in the US, the so-called Chamber of Commerce, urged the Trump administration to end its trade war with China.

There are still potential risks to a trade deal though. The worst-case scenario would be that both parties remain at an impasse without any agreement on key principles and the US proceeds to apply an additional 25% tariff on $ 300bn of Chinese imports.

Turning to the brewing Iran-US conflict, it appears that both sides do not want a war and hence, although more headlines on this topic in the coming weeks are likely, it may not be right to reduce exposure to equities on account of this conflict. However, the temperature of the conflict did rise – and so did oil - this week with the news that Trump ordered a military strike on Iranian targets in response to Tehran’s shooting down of a surveillance drone before reversing course and deciding not to strike.

For remaining market weight in equities whilst holding risk-off assets too, like gold, seems sensible. One of the negative things that people say about gold is that it does not have a yield but it is worth noting that neither does $12.5trn of government debt!

© 2019 GWM