Have markets ‘run out of road’?

26 August 2016

The great vacation is upon us, at least in equity market terms. The profit-taking from last week’s highs has not led to much sense of increasing risk. The FTSE’s move below 6800 brought out the “dip”-buyers not sunning themselves in the glorious British weather.

Still, there are somethings of note and, to follow on from last week’s discussion about government bonds.

UK yields fell immediately after the referendum, as the Governor of the Bank of England signalled a rate cut. The fall in sterling raised inflation expectations for the short-term but longer-term expectations were not altered too much. However, the past couple of weeks have seen real returns in the “risk-free” long end decline to historical lows of below -1.5%.

The implication seems to that UK inflation will climb to 3% in 10 years’ time and stay there for a number of years (the 10-year forward calculation is done by the Bank of England). So, the question is this; is this a reflection of all investors’ combined wisdom or a fix by the Bank of England?

This is particularly pertinent in for risk assets. If it is a fix, then the Bank of England is essentially giving us a bonus to hold those risk assets, and in a pretty general manner. If it isn’t, it means risk assets are especially risky; investors will need to be especially choosy over the coming years.

We’ll get more into this debate over the coming weeks.

On the economic front, we’ve had a run of near-consensus data; UK 2Q GDP data coming in at an expected 0.6% rise on the quarter; Europe “flash” purchasing manager reports showing mild strength; US durable goods being on the strong side but the service PMIs softening after a long period of strength.

The UK housing data continues to be of some concern.

Next week, Lothar is back so expect decidedly more insight.