- Weekly update
- 5 minute read
A good week for
- US equities rallied c. +2% in sterling terms, boosted by dollar strength
- Oil gained over +2% in US dollar terms
A bad week for
- Non-US equities weakened, with emerging markets falling furthest in sterling terms
- Bonds weakened across the board
US monetary policy
January’s US central bank meeting was received hawkishly by markets. The US Federal Reserve’s Open Markets Committee agreed to leave interest rates unchanged, and end asset purchases in early March, setting the scene for a March interest rate hike. The policy statement noted that "with inflation well above two percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate". The report also included a new addendum on “Principles for Reducing the Size of the Federal Reserve's Balance Sheet”. This indicated that net sales of balance sheet assets, quantitative tightening (QT), would happen after rate hikes and would be conducted in a predictable way. However, it did not give details of how quickly assets would fall, or what level the Fed expects asset
holdings to fall to. Market expectations of monetary tightening rose further, with derivatives markets indicating five hikes are expected in 2022. However, this would require double-pace rate hikes, alongside balance sheet reduction, which may be ambitious
Bitcoin continued to slide last week, with cryptocurrencies falling again. The weakness coincided with a period of broad volatility for markets, as investors priced in more monetary tightening. Some investors had seen a role for cryptocurrencies, such as Bitcoin, as a diversifying asset within portfolios, similar to gold. While gold has relatively few uses, it has a relatively low correlation with equities and bonds and, as a real asset, offers some inflation protection. Recent volatility calls into question the efficacy of this strategy, with cryptocurrencies recently moving in tandem with risk assets.
US GDP growth was stronger than expected in the fourth quarter of 2021, despite the Omicron wave weighing on activity in December. Quarter-on-quarter annualised, the
economy grew by 6.9%, beating expectations. However, the detail of the print showed that business inventory building was a significant contributor, adding 4.9 percentage points to growth. Normally, this would point to weak growth in the following quarter, as inventories unwind, but supply chain challenges may mean this is less applicable. Stronger inventories may in fact support supply chain recovery and better consumer choice once the Omicron wave has passed.
UK public sector net borrowing was higher than expected in December, due to higher inflation, though cumulative borrowing for the fiscal year remains below expectations. Net borrowing was £16.8bn, modestly above the OBR forecast. Higher inflation is making it more difficult to restore public finances to pre-pandemic levels, with higher Retail Price Inflation increasing the coupons payable on index-linked debt. This headwind was offset by better-than-expected tax receipts, £68.5bn versus £64.3bn, due to stronger growth than the OBR had forecast. The question now is what Chancellor Sunak will elect to do in the spring. Households face tax rises and an increase in the energy price cap, which will weigh on incomes. Better-than-expected receipts give the Treasury more room to relent on at least one of these policies, while remaining within the new fiscal rules.
Last week’s GDP prints from Europe showed significant economic divergence. Germany experienced a 0.7% quarteron-quarter decline in Q4, with manufacturing hindered by supply chain bottlenecks and the services sector crippled by a wave of Delta infections. France, stable for most of 2021, grew by 0.6%, bolstered by consumption spending. Spain, the laggard for 2021, grew by 2%, driven by strong investment and inventories, offsetting a decline in consumption. Growth is likely to be weak at the start of the first quarter, with social restrictions in place in many Eurozone countries, but lower hospitalisation rates point to a rapid easing into the spring.
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