February Market Overview - Redwood Business
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February Market Overview

February Market Overview

Italy Prepares For Election

 

Investors will be casting an eye on the momentum of each Italian political party as they prepare to go to the polls on March 4th. The European Union (EU) also stated their terms for the transition period with the UK and the International Monetary Fund upgraded their forecasts for global growth.

 

Italian Election

In December last year, the Italian president, Sergio Mattarella, dissolved parliament which gave way for a snap election called for 4th March 2018. This will be the first vote based on the new electoral system (Rosatellum) that was ratified last year. Italian politicians demanded this new system mainly to increase the probability of one party achieving a majority of parliamentary seats. Despite this, it is highly likely that the vote will still end in a coalition. The two leading individual parties, the anti-establishment M5S (Movimento 5 Stelle) and the centre-left PD (Partito Democratico) look as if they will fall short of the votes they need to win a majority.

 

If the polls are right, and as with all polling it must be taken lightly, it will be hard for a single party to form a government. As a consequence, coalition negotiations are likely to be crucial if either party is to be able to form a new government. One risk for markets is that a government is formed that includes the parties who are sceptical of the euro as a currency. However, in recent months the recovery of the Italian economy and rising employment has stalled the momentum of some of the anti-euro rhetoric of populist parties and support for the euro is now rising in Italy.

 

One of the potential outcomes is that the election results in a fragile coalition government, which will then not be able to accelerate the structural reforms needed to support a sustainable economic recovery. This further period of political uncertainty would not be great news for investors. However, it must be taken into account that Italy is well known for their coalition governments which have now spanned over a fifty year period. The comforting thought is that this historic political uncertainty has not hindered confidence or economic activity in other European countries – most notably in Germany and Spain.

 

Brexit

The divorce bill has been agreed and the UK Government are looking to implement a transition deal which would mean that we would essentially remain members of the European Union until 31st December 2020. The European Union have now given guidance on what they expect from the UK during this transition period. All EU regulations will continue to apply to the UK during the transition period. This will include any EU laws made during the transition period. Freedom of movement is likely to continue as the UK will still have access to the single market and free movement is one of the four pillars which is part of the constitution of the European Union. Michel Barnier, the chief EU negotiator, also stated that the UK would be able to negotiate trade deals with other nations but any trade deals would not be ratified until the transition period was over. This date is likely to be 31st December 2020 but this has not been agreed as of yet.

 

US

After much deliberation and build up, the Republicans finally passed through their Tax Reform bill. US Corporations are now seeing their tax rate cut to below what many of their competing corporations pay elsewhere under a sweeping plan that is slashing the corporate tax to 21% (down from 35%) and largely ending the taxation of non-US earnings. For companies, the average top corporate tax rate worldwide is 22.5%. The proposed new US rate would come in below France’s 34%, Australia’s 30% and Japan’s 23% corporation tax rate. This new legislation will be good news for businesses, particularly multinational corporations and the commercial property industry.

 

The Federal Reserve raised short term interest rates for a third time in December 2017 and predicted more increases to follow this year as Janet Yellen prepares to hand over the chair to Trump’s nomination, Jay Powell. The US central bank’s Federal Open Market Committee increased the target range for the federal funds rate by a quarter point to 1.25-1.5%. Policymakers’ forecast that they could rate hikes to 2% in 2018 and 3% in 2019, even as they acknowledged inflation is continuing to undershoot their target. This is positive news for the US economy and shows how advanced the US central bank is in terms of monetary policy compared to the rest of the world.

 

International Monetary Fund Outlook

The managing director of the International Monetary Fund, Christine Lagarde, gave a keynote speech in Davos where the forecasts for global growth were upgraded and the confidence in the world economy was substantiated. Lagarde evidenced economic indicators such as the strong Purchasing Manager Index figures apparent in Europe and the slowdown on the reliance of economies on central bank stimulus. This development of monetary policy is in an advanced stage in the US, with the Federal Reserve looking to buyback the $4.5 trillion in bonds held on their balance sheet and three to four interest hikes predicted in 2018. The world economy is likely to grow 3.9% this year and next, the IMF stated, up 0.2 percentage points for both years on the back of a better outlook in the US and eurozone.

 

Europe

The European Central Bank (ECB) decided to keep interest rates at record lows and restated their commitment to keep monetary stimulus in place and potentially expand quantitative easing if it is necessary whilst inflation continues to stay below target. The ECB’s governing council repeated that it expects interest rates to remain at present levels until the end of its quantitative easing programme and they will continue with the purchase of €30bn of bonds each month. Policymakers have stated that this could be potentially increased until indicators see more signs that the inflation target will reach 2%. The central bank have scheduled the end of the quantitative easing programme for the end of September 2018. However, policymakers have indicated this could be extended depending on economic indicators/forecasts closer to the time.

 

The central bank have been comforted by Eurozone growth reaching its highest level in a decade. The Eurozone surpassed the US and UK, growing by 0.6% in the third and fourth quarter of last year. The annual growth rate for 2017 was 2.5%, the highest level reached in ten years and up from 1.8% in 2016. The US expanded by 2.3% and UK by 1.8% last year. The political stability of Europe last year helped to provide confidence to companies and investors. The win for Emmanuel Macron in France’s presidential and parliamentary elections was a typical example of this. French gross domestic product rose 1.9% in 2017, the fastest since 2011. Capital spending is widely seen as indicator of investment confidence and this rose to 3.7% up 1% from the figures produced in 2016. These positive figures has given optimism to global growth and economic sentiment across Europe.

 

Asia

Gross domestic product for Japan in 2018 is now projected to grow 1.8% year on year in price-adjusted real terms, up from the previous estimate of 1.4%, illustrated by the latest government economic forecast. This has been supported by Japanese industrial production which has grown faster than expected. Industrial production rose 2.7% month on month in December, according to the data produced from the Ministry of Economy, Trade and Industry. In year-on-year terms, production rose 4.2%. Whist Japan has continued their policy of ultra-low interest rates in a bid to halt deflation and low growth, some in the market have speculated that the Bank of Japan could join the European Central Bank and the Federal Reserve in scaling back their stimulus plans. This will be dependent on inflation expectations and whether it reaches their target of 2%.

 

Conclusion

Interest rate rises and the tightening of monetary policy suggests that the global economy is healthy. Trump has now managed to push through his tax reforms and this is likely to be beneficial for US corporations. It will certainly be interesting to see the outcome of the Italian elections in March as this could affect European markets. The ongoing Brexit negotiations will continually be at the forefront of investor’s minds until a trade deal has been granted.

As at 1st February 2018

 

 Source: Financial Times