In his regular column, Jeff Lewis director at RobMac gives his excellent summary overview of the US & UK economies and investment markets.
It is part of Fed history that they caused the inflation of the 1970s by misinterpreting a rise of inflation as temporary. They do not want to repeat that mistake. Moreover, with the US economy having recovered completely from last year’s pandemic-induced recession, there is no need to maintain rates at emergency low levels. This means interest rates are likely to rise in the near future perhaps by Christmas or early New Year.
The Bank of England is in a similar position. Indeed, they are set to raise rates earlier and further than the Federal Reserve. Sterling has so far been remarkably unaffected by the prospect of rate rises in the UK. We can look ahead to some further appreciation of sterling, especially as the signs from negotiations with Europe are that we will avoid a trade war. Indeed, the UK negotiators seem to have wrung important concessions from the EU with respect to the Northern Ireland protocol.
What does all this mean for Investment markets ? To answer that, we must look to the earnings being reported by US companies. Are they saying that rising input prices and rising wages are squeezing margins or are they using strong demand to push up prices and grow earnings strongly? There will of course be a mixture of both, but there is a feature of the US economy that few have noticed that is bullish for equities in the medium term: there is an investment boom underway in the US. That typically leads to stronger growth and better earnings. Investment is picking up in the UK, Europe and elsewhere in the developed world too.
All in all, the background is complicated. Rising interest rates are undoubtedly a headwind for risk assets. Some companies will see their margins squeezed. But the global economy continues to expand and that means risk assets should outperform. Investment markets lost a bit of their fizz in the last couple of months but hopefully we’ll see returns becoming more positive again for the rest of this year and beyond .
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