Market Commentary – July 2019

US Fed cuts rates by 25bps

The much-anticipated rate cut by the Fed was announced at the end of the month, and, as expected, bond yields, which had already moved lower, ended the month markedly down around the world. Equities were less enthusiastic about the cut, however, focusing on the fact that two of the Fed committee dissented from the decision, citing low unemployment and the likelihood that inflation would edge higher to meet the 2% target. The Fed statement also indicated that it did not anticipate an extended period of rate cutting.

New PM sees sterling slide on Brexit worries

Boris Johnson’s election as leader of the Conservative party came as no surprise to anyone, but his early pronouncements on the subject of Brexit, and his commitment to leave the EU at the end of October with or without a deal, caused renewed worry in the markets. Concerns that a no-deal Brexit, might have negative consequences for UK jobs, consumers and the economy, led to a sharp fall in the value of sterling, which returned to the levels last seen, briefly, after the Brexit referendum in 2016. The Pound ended the month more than 4% lower against the Dollar.

Emerging markets hit by new trade dispute

Emerging markets, though weaker overall in July. There were some positive returns from Europe, but in Asia and South America, markets were battered first of all by the lack of positive news coming out of the G20, where Trump and Xi were expected to revive trade talks, and secondly by the start of another trade dispute, this time between Japan and South Korea. Data showed that South Korean consumers had been boycotting Japanese goods after Japan tightened export curbs on South Korea in June.

European data continues to point to a two-speed economy

After a promising start to the year, the Eurozone economy looks to be running out of steam, and economic data is pointing to a two-speed economy, with a robust services sector struggling to offset poor manufacturing data. The Q2 Manufacturing PMI saw its worst number since 2013, whilst unemployment continued to head lower, and the services business activity index rose to a seven-month high.

The figures above are flattered by the weakness of Sterling over the month. In local currency terms, the UK was the best performer, rising by more than 2%, but the Pound’s fall against, particularly, the Dollar, meant that better returns were found in the US for sterling investors. Emerging markets were mixed, and lower overall, but provided some of the best gains in Europe, as investors cast their net wider in the search for positive returns.

July saw a reversal of the trend seen recently, as the peripheral, Southern and Eastern states outperformed the major economies. The EU as a whole turned in a positive, but pale performance (in sterling terms) compared to other major markets, as economic data and the increasingly real threat of a disorderly Brexit began to weigh on investors’ minds across the continent. Emerging European markets saw a much better return, with Turkey up over 15% and Romania gaining 6%.

The election of Boris Johnson as Conservative leader, and hence Prime Minister, appeared greatly to increase the chances of a no-deal Brexit in October. Sterling, which is the barometer for Brexit sentiment, fell sharply against the Dollar and other major currencies in the latter part of the month, and showed no signs of rallying in any convincing fashion from its lows. The Euro also weakened, albeit to a lesser degree, as a disorderly Brexit is likely to be damaging to various degrees for the nations of the EU. The EU member likely to be hardest hit is Ireland, which is also the country that is objecting to the removal of the Irish border backstop.

Expectations of a US rate cut, and the reality of the 25bps cut at the end of the month sent bond yields lower around much of the world, with the notable exception of the US itself, where the cut had already been fully priced in. Fears that the Sino-US trade dispute would cause a global slowdown did not diminish after June’s G20 meeting, and talk turned to looser monetary and fiscal policy in major markets, and a possible return to some form of quantitative easing, particularly in the EU, where government bond yields fell further into negative territory during the month.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

Boris Johnson: Cometh the man?

July saw the long-awaited conclusion to the one-horse race that was the Conservative leadership election, and Boris Johnson installed as the new Prime Minister, inheriting the Brexit deadlock that ended the tenure of his predecessor, Theresa May.

Johnson has a reputation as being a showman and lacking substance; specifically, he is light on detail, as demonstrated by his failure adequately to study his brief as Foreign Secretary. What he does have, however, is a style of Churchillian rhetoric that may play well with MPs in terms of building support both within and without Parliament for the no-deal Brexit that Theresa May would not (and indeed could not) implement. His initial speeches have been aimed at galvanising sentiment, rallying popular support, and sending a message to the EU that Britain is now on the front foot. He has been very clear, since his leadership campaign began, that he believes the EU will re-open negotiations, and equally clear that he will take Britain out of the EU without a deal on 31st October if it does not.

Whether or not the bureaucrats in Brussels believe him, it is clear that the markets do, with the Pound, which had weakened during the preceding three weeks, taking a further hit towards the end of July. Johnson has made a very public show of appointing a diverse and strongly pro-Brexit cabinet. He has also put his political money, and tax-payers’ actual money, where his mouth is, announcing a huge and expensive ramp-up in preparations for a no-deal scenario. Since March, bookmakers’ odds on a no-deal Brexit have moved from 5/1 to 7/5, and Johnson is keen to convince the EU that a no-deal Brexit is now a real possibility. With the latest announcement of another £2.1bn for no-deal planning, the total spent so far this year on this contingency comes to £6.3bn: a large, and at the same time very small amount, depending on your point of view.

Of course, notwithstanding parliament’s machinations aimed at blocking a no-deal Brexit, it does seem as though the chances of this scenario being played out have increased. Johnson has made the dropping of the Northern Ireland backstop a precondition for the re-opening of talks. The EU has shown no willingness to re-open discussions on this sticking point, which it already sees as a huge concession to Britain. The backstop acts as an insurance policy that maintains an open border between Northern Ireland and Eire. To remove it would place the EU in a position whereby it could be forced to accept tariff and quota-free trade across the Irish border, completely disregarding EU regulatory standards, and compromising the integrity of the single market. However, accepting an open-ended backstop arrangement would mean keeping Britain tied closely to the EU for an indefinite period until a permanent solution could be agreed. Boris Johnson has made vague statements to the effect that there can be a technological solution to this problem, but this seems unlikely, given the difficulty of devising and implementing such a solution in the short time available. One solution, allegedly supported by the DUP, would be for a time-limited backstop as a quid pro quo for an agreement on a whole-of-Ireland food regime. This could be limited to a transition period of, say three years. This might fit with Irish Prime Minister, Leo Varadkar’s aim of restricting checks on meat and food products in order to keep the border open. Outside of an arrangement such as this, the Irish government remains implacably opposed to removing the backstop, which it sees as the only guarantee against the return of a hard border, and all the problems associated with the period before the Good Friday Agreement.

Of course, if Boris is to take Britain out of the EU on 31st October, with or without a deal, he must first survive as Prime Minister until that date. Recent announcements on more cash for the NHS and policing sound suspiciously as though the groundwork is being laid for a general election. The likely trigger for an early election (the Fixed-Term Parliament Act of 2011 means that one is not due until 2022) would be a vote of no-confidence initiated by the Labour party. It is hard to see what Labour would gain from such a strategy, given the unpopularity of Jeremy Corbyn, and that, based on the recent Brecon by-election a general election tomorrow might even see them lose their position as the main party of opposition. Also, dissolving parliament ahead of 31st October might see Britain sail through the deadline without a deal in the absence of anyone to take preventative action. Nevertheless, Labour has strongly hinted that it will pursue a vote of no confidence when parliament returns in September.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

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