Last week was eventful, both in terms of policy and economic data. Equities were typically up between 0.5 and 1%. In the US, the S&P closed above 2000 for the first time and managed to sustain that level throughout the week. European equities rose by 2-3%, helped by the actions of the European Central Bank (ECB).
In Asian markets, both Japan and China were strong, boosted by confidence that China was doing reasonably well from a policy and growth perspective. The main laggard of the week was the UK, on evidence that the Yes vote in the Scottish independence poll was gaining ground. The biggest impact of this was on sterling, which saw considerable weakness, particularly against the dollar.
On the fixed- income side, both government and corporate bond yields drifted higher, largely on profit-taking but also on concerns that the US Federal Reserve’s view is becoming increasingly hawkish, making an early rise in interest rates more likely. The other main theme across markets was the stronger dollar, most in evidence against sterling, but also versus the euro, the yen and emerging-market currencies.
Quantitative easing – by another name
The key event of the week was the meeting of the European Central Bank (ECB). There had been much speculation that we would see the ECB establish a quantitative easing (QE) programme, as economic data over the past few months had shown sustained weakness in the core heartlands of Germany and France, and inflation was slipping below the 1% level.
The ECB did take action by cutting interest rates, but more meaningful was the ECB’s announcement that it would purchase asset-backed securities – this was dubbed “private QE” by the market. While there was some disappointment that the purchase of government bonds hadn’t been announced, it is quite possible that we’ll see this further down the track. Overall, this action was taken positively, and is obviously supportive of European banking because it helps free up the bank- lending channel. It is also positive for European equities, where we believe markets are among the cheapest on a global basis. The weak euro also helps corporate earnings.
Geopolitical crises dominate politics
On the politics front, last week’s focus was the Nato meeting in Wales. The focus was twofold: the approach to dealing with Russia and Ukraine, and a more coherent plan for the crisis in the Middle East. On the first point, despite the announcement of a brief ceasefire, we expect to see ongoing friction on the Russia/Ukraine border. This isn’t currently creating a huge amount of volatility but, given Europe’s dependence on Russian natural gas, especially as we approach the winter months, energy supply could cause problems. In the Middle East, pressure is building on western governments, particularly the US, to articulate a more coherent plan of action. The challenge is that this would require working more closely with the Assad regime in Syria, and negotiations with Assad could involve Russia. So in some ways, the two crises are linked, which gives a sense of how difficult the situation is from a political - negotiation perspective. While events in the Middle East have also had little impact on markets yet, with crude-oil reserves still high and the oil price weak, this could turn around pretty quickly, especially as the winter months approach and demand increases for heating supplies.
The implications of Scottish independence
The biggest focus in terms of market volatility here in the UK is the Scottish independence vote. The referendum takes place next week – on the 17th, with the results available two days later on the 19th. (I would draw your attention to a 10-page document our BlackRock Investment Institute produced in March, which runs through the implications of a Yes vote.) The key focus is the currency, where Chancellor George Osborne has made it very clear that he would not be willing to let Scotland use sterling on a longer-term basis. It’s worth pointing out that nothing would happen immediately following a Yes vote, because the first date at which independence could take place would be March 2016. But it seems likely that a Yes vote would create a great deal of volatility and uncertainty, particularly in terms of currency, and exactly how much of the gilt market Scotland will own.
A Yes vote would also have implications for a number of large companies that are currently headquartered in Scotland, as they would need to decide where to base themselves.
Policy highlights in the coming week
In the UK, house-price data, retail sales and industrial production figures will be published. Given the focus on the strength of the UK, and the potential for interest-rate rises, these will all be considered important pieces of the economic jigsaw puzzle. So we may see some volatility based on these releases. In the US, official releases include retail-sales data, and in the eurozone, inflation data, which has so far been a key influencer of ECB policy. Last but not least, it’s clear that the geopolitical issues described above will not go away any time soon and will continue to generate news headlines and cause volatility. But at this stage, markets are not paying a huge amount of attention to events in Ukraine and the Middle East.
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