How Windy Is It . . . ? Monday, 13th March 2017 – No.220
In many ways since the surprises of the ‘Brexit’ and Trump votes, the US and UK have been in ‘phoney war’ territory as markets have been scrabbling to understand both the nature and quantum that these seismic changes will bring. It now looks like we are about to find out. In the UK it looks likely that Mrs May, subject to winning a vote this evening in the House of Commons, is about to trigger Article 50, the mechanism for Brexit, as early as tomorrow. So the phoney war will be over as the two year starting gun to the UK’s divorce from Europe will have been fired. The focus will then turn not only to the mechanics of departure, as well as the cost of the ‘divorce bill’, but also the likelihood of the UK being able to strike trade deals with all 27 EU countries. Failing to achieve this would result in intensified uncertainties in terms of the environment for both regulation and trade tariffs.
In the US there has been a significant shift in the markets expectations on interest rate hikes by the Federal Reserve. Only a few weeks ago the likelihood of a rise in short term interest rates in March were low. It now appears almost a certainty. The main focus of both equity and bond investors will not be on the 25 basis point likely increase but the text of the accompanying statement by Fed Chair Janet Yellen. It is worth remembering the quotation by William McChesney Martin, the longest serving Fed Chairman, who famously stated that the Federal Reserve ‘is in the position of the chaperone who ordered the punch bowl removed just when the party was really warming up’. In modern parlance this means that the Federal Reserve needs to ‘be ahead of the curve and not trailing it’.
The US economy seems to be in pretty rude health as last week’s employment data beat expectations. Official data showed an extra 235,000 jobs being added in February (expectations were for 190,000) and the unemployment rate falling to 4.7%. This is before Mr Trump and Congress has actually done anything about reducing taxes (fiscal stimulus). So the chances that short rates will increase three times this year have risen but there could be even sharper tightening. The market now has the odds of four rate rises at 25%, up from 12% at the end of January. The shape and rate of interest rate rises will prove critical to returns from both US bonds and equities. The last time that the Federal Reserve really had to step on the brakes was in 1994 when the US yield curve shifted sharply higher and this proved a difficult environment for both bonds and equities that year. Having said that by getting back ahead of the curve and curtailing inflationary pressures early set up equity markets for a prolonged period of strength.
Mergers and acquisition activity (M&A), whether transatlantic or more local remain robust. Akzo Nobel the European paints giant, perhaps best known for its Dulux paint brand, received an unsolicited bid from its US rival PPG Industries Inc. while in the UK, Wood Group agrees the takeover of rival Amec Foster Wheeler. This follows hot on the heels of the opportunistic approach by Kraft Heinz to Unilever. It seems likely that M&A activity will remain high partly driven by the sharp depreciation in Sterling.
Finally last week evidenced Mr Hammond’s UK budget, which is unlikely to have won him any popularity contests. Not only did he increase National Insurance Contributions (NIC’s) for the self employed (on the basis it was making the cost gap closer between employed and self employed) but also cut both the tax free dividend amount from £5000 to £2000 from 2018 as well as increasing probate costs by up to 9,300%. The latter looking suspiciously like a stealth death tax. I suppose we should just soberly reflect on the 1789 quotation usually attributed to US president Benjamin Franklin ‘Our new Constitution is now established, and has an appearance that that promises permanency: but in this world nothing can be said to be certain except death and taxes’.