UK inflation hits 1% in July as lockdown restrictions ease
As global economies continue to emerge out of lockdown, a promising recovery in oil, clothing and footwear prices has caused a jump in inflation to 1%. This exceeded expectation of Bloomberg economists who had predicted a rise of 0.7% in July.
The rise in inflation has been instigated, in part, by the largest increase in international oil prices in almost a decade as they rose from the historical lows (prices on wholesale markets were actually negative) from April. Prices of commodities such as oil have a strong positive relationship with inflation and so the rise in oil price correlates with the rise in inflation.
The Bank of England had predicted earlier this year that inflation would fall to near zero during 2020 as a direct result of the pandemic. Despite the recent positive jump, the Bank of England’s prediction could still hold true as fears of a deflationary wave remain genuine as the unemployment levels threaten to rise as we move into quarter four. The Bank of England has also previously warned that further lockdown measures and the strong possibility of a large spike in unemployment is expected to result in inflation falling to -0.3 per cent in August.
Inflation has a direct causation relationship with the performance of many asset classes. Those people with larger levels of cash savings will not benefit from this rise in inflation as the real return on the money is decreasing at a faster rate. Interest rates have been successively cut and now sit at historic lows.
Fixed Income securities such as bonds also do not welcome high levels of inflation as the fixed income produced by these assets will reduce in real value over time due to inflation. As a result, bond prices tend to fall when inflation is increasing.
The impact of inflation on general equity markets cannot be generalised but in theory, certain stocks should provide a slight hedge against inflation if a company has pricing power for its goods or services.
US S&P 500 Index reaches new high
US stocks have performed remarkably well over the last few months, despite the economy shrinking, with a record-breaking bull run in the months preceding March. The S&P 500 is regarded as the best representation of the US stock market, measuring the performance of 500 of the largest US traded companies. On Tuesday the Index set a new record of 3389, regaining and exceeding heights not seen since early February.
This record is especially remarkable given the economic backdrop caused by the pandemic. With expectations of large-scale recessions globally, exceptionally high US unemployment figures and the country still struggling to control the virus with relatively high infection rates, it is hard to fathom such impressive stock market performance.
The ability of markets to recover so quickly is largely down to governments stimulus packages, with huge QE introduced across the globe. The FED has committed to continue providing stimulus, while other governments have followed suit with similar stimulus packages. Investor optimism, underpinned by massive liquidity, is another reason for the rise; government responses have instilled confidence in markets, while a re-opening of economies and a reduction in lockdown restrictions have allowed economies to re-start from their essentially frozen state.
Tech stocks can be seen as one of the winners of lockdown, boosting the growth of the S&P 500 and potentially offsetting the performance of sectors hit harder by the pandemic. Various technology companies have benefitted from the shift to working from home, with companies such as Zoom and Microsoft teams becoming an integral part of businesses across the globe. Although economies are beginning to reopen, the change in work practises could be here to stay for many, with employers and employees alike pleasantly surprised with the shift to WFH. Although the driver for US stocks seems to be optimism at present, there are developing concerns about the disconnection between certain sectors within the stock market and health of the real economy.
UK officially in recession for first time in 11 years
The UK is officially in recession after the economy suffered the largest decline ever recorded in Quarter Two as the lockdown measures forced the world to close down. PM Boris Johnson, has warned that the UK has a "long, long way to go" before the economy improves due to further figures showing the biggest drop in employment in over a decade.
A 20.4% plunge in GDP in the second quarter was followed a 2.2% contraction in the first quarter. Two consecutive quarters of contraction is the economists definition of an economy in recession. The collapse in output was directly driven by lockdown measures forcing shops, hotels and restaurants to close. The lockdown measures particularly impacted the UK as the services sector suffered the largest collapse in history and this influences four-fifths of the British economy.
As government restrictions have began to ease across the UK and the public returns to some level of normal activity, the Office for National Statistics has reported that the economy has grown by 8.7% in June. Although this offers some encouragement the Bank of England and the government’s forecasters do not expect the economy to reach pre-pandemic levels until the end of 2021 and possibly even 2022.
A year without precedent
Markets have had a great deal to negotiate this year. Looking forward, the final quarter is likely to be volatile, both in terms of economic activity and also geo-politics. At the time of writing, it is virtually impossible to predict the outcomes of, for example, the US elections, any development regarding Covid-19 or the US/China trade talks. Of course, this will not stop commentators from attempting to make convincing forecasts and these are likely to cause global asset prices and currencies to move in unexpectedly surprising directions.
Sadly, we at Reeves do not possess a crystal ball that is any more effective than anyone else. What we do have though, is a decent understanding of the fundamentals that drive markets and a medium to long term investing horizon. This means that we will not be tempted to make knee-jerk reactions to anticipated market noise and that we will endeavour to steward our Clients assets as if they were our own.
UK remains hopeful in reaching an EU trade deal
According to Downing street, the UK believes it can agree a trade deal for after it leaves the EU at the end of this year. Both sides remain particularly divided on fishing rules and transport cooperation however this week is the last scheduled set of negotiation meetings before the Autumn. The December deadline is looming, and an extension has been ruled out by the UK.
Currently the biggest obstacle facing both sides is that they both wish to be on a level playing field when it comes to trade and the marking of the ‘origin’ of products. Negotiations are stalling on multiple sticking points as the EU has warned that the UK cannot have the same access post Brexit. Pressure for a last-minute deal is mounting as a no deal exit would be a major risk for the UK government. Naturally, EU negotiators will not wish to be seen to be adopting an overly cooperative stance (in public anyway) in case this sets any precedents in the event of any other EU member country wishing to consider a similar course of action as that taken by the UK.
Sterling is likely to take the strain first as any negotiations unfold and investors both domestic and international will weigh up any potential implications for corporate profits (70% of FTSE100 profits are derived overseas) and bond markets.
Disclaimer: This document represents the opinion of Reeves Independent only and is not intended as advice and no investment decisions should be made solely on the back of this email. Always seek independent financial advice before taking any action. Past performance is not a guide to future performance. All investments carry the risk that you will get back less than you put in.
Gold shoots above $1,800 for first time since 2011; https://www.ft.com/content/b5d9e57f-74f6-4445-88bb-ca6ddff20525
Oil prices edges up on weak dollar, U.S.-China tensions weigh; https://www.reuters.com/article/us-global-oil/oil-prices-edges-up-on-weak-dollar-us-china-tensions-weigh-idUSKCN24P04M
Weekly Market Round Up; https://www.psigma.com/psigma-voice/weekly-roundup/
Coronavirus vaccine: UK government signs deals for 90 million doses; https://www.bbc.co.uk/news/health-53469269
Government to develop £100m Covid-19 vaccine manufacturing centre; https://www.theguardian.com/world/2020/jul/23/government-to-develop-100m-covid-19-vaccine-manufacturing-centre
New study reveals Oxford coronavirus vaccine produces strong immune response; https://www.ox.ac.uk/news/2020-07-20-new-study-reveals-oxford-coronavirus-vaccine-produces-strong-immune-response
Brussels to warn time is running out for Brexit deal; https://www.ft.com/content/272974a2-1d25-4a1a-aab4-b4bcfe2bbc3a
Fears EU-UK trade talks will bear no fruit until autumn; https://www.ft.com/content/38223a68-c6b6-46e9-847e-f112af552a0e
Post-Brexit deal: What's happening in the UK-EU talks?; https://www.bbc.co.uk/news/uk-politics-53518641
Cornoavirus: UK economy has 'clawed back half of lost ground'; https://www.bbc.co.uk/news/business-53473616
'V' good? How Britain's economic recovery is shaping up; https://uk.reuters.com/article/uk-health-coronavirus-britain-economy-gr/v-good-how-britains-economic-recovery-is-shaping-up-idUKKCN24O24F
UK economy rebounds more slowly than expected; https://www.bbc.co.uk/news/business-53400721
UK economic recovery tracker: what the latest data on activity are signalling; https://www.ft.com/uk-econ-tracker
Markets are right to be nervous about the US election; https://www.ft.com/content/af5ee2c0-d53c-4437-8b98-5e8341ffbcf5
How The Markets Will React To The 2020 Election; https://www.forbes.com/sites/simonmoore/2020/07/18/how-the-markets-will-react-to-the-2020-election/#44b9ff4b5ee1
Chinese GDP grows 3.2% in second quarter; https://www.ft.com/content/4a0f9dca-b48c-453f-bfc1-2c6c8b55682a
China GDP: first major economy to show a recovery from coronavirus damage with 3.2 per cent growth in second quarter; https://www.scmp.com/economy/china-economy/article/3093371/china-gdp-economy-avoids-recession-second-quarter-growth-32
Coronavirus: Chinese economy bounces back into growth; https://www.bbc.co.uk/news/business-53399999