By Jan Faure
Global equity markets were mixed in July with the UK’s FTSE 100 Index being the best performer following pound weakness as Boris Johnson became the new British prime minister.
As expected, the US Federal Reserve cut interest rates by 25 basis points on Wednesday. Stocks declined after the Fed said the move wasn’t necessarily the “beginning of a lengthy cutting cycle”. Markets were pricing in a series of rates cuts so the unclear message from the Fed led investors to take profit across equity markets.
Significantly, the US rate cut was the first since December 2008 during the global financial crisis, when the Fed dropped rates close to zero and kept them there until 2015. After that, the Fed went on to make nine 25 basis point rate increases from December 2015 to December 2018.
One of the reasons the US is cutting rates is to weaken the dollar, or make it more competitive against other currencies as a buffer against slowing global growth and trade. The issue facing the Fed, however, is when the three major economic zones (USA, Europe and Japan) are all simultaneously engaging in monetary easing, the effect is diminished. And indeed, following the Fed rate cut the dollar strengthened as the market took the view that, going forward, the ECB and the Bank of Japan will ease policy more aggressively than the Fed.
Economic growth in the Eurozone slowed in the second quarter with annualised GDP growth of 1.1%, its weakest rate in five years. This is another statistic which increases the likelihood of European Central Bank stimulus. The ECB could cut rates at its next meeting in September and even announce a new round of quantitative easing (QE).
China and the US concluded their latest round of trade talks in Shanghai following a pause of almost three months, with no breakthrough being made toward ending their year-long trade dispute. Talks are set to resume in Washington in September.
Boris Johnson was elected as the new British prime minister. With his election, the probability of a no-deal Brexit increased since he is a hard-line Brexiteer willing to leave the European Union whatever it takes.
The risk of a no-deal Brexit reflected in the performance of the pound which has lost around 3% in value since Boris Johnson became prime minister. The slide could continue right up until the 31st October, the date that Britain is scheduled to depart the European bloc.
The decline in the pound is a reflection of the market’s belief that Britain will be economically weakened by Brexit, even more so by the prospect of a no-deal Brexit. A weaker pound will make British exports more competitive, however since Britain is a net importer, the net effect is negative for the UK economy. Boris Johnson has been successful in convincing the British people that the future of Britain is bright and prosperous outside of the union, but he certainly hasn’t convinced markets.
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