Guy Foster, Chief Strategist, discusses the UK and US budgets, while Janet Mui, Head of Market Analysis, analyses the latest US jobs report.
There was some modest volatility in equity markets last week as Apple and Tesla came under pressure from investors concerned about their Chinese growth. Apple has been losing market share to Huawei while Tesla has been engaged in a price war with BYD – something it appears to be losing.
As members of the ‘Magnificent Seven’ large cap techenabled companies, weakness in Apple and Tesla caused a meaningful sell-off on Tuesday, but it didn’t take long for normal service to resume. The NASDAQ and S&P500 were back at all-time highs by Thursday.
The ECB announces no change
Thursday also saw the European Central Bank (ECB) announce monetary policy to a distinct lack of fanfare. No change in policy was expected and none was delivered. However, the ECB’s language seemed to turn hawkish. Although this was the least momentous feature in terms of market impact, it certainly highlights a critical area where some complacency might be creeping into markets.
The ECB replaced the statement, “the declining trend in underlying inflation has continued” with “although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages.”
Therein lies the risk – it is very much assumed that interest rates are restrictive and the next move in them will be to loosen. Headline rates of inflation have declined, and yet one of the causes of inflation, higher wage growth, remains evident. As a consequence, services inflation has been running well above target in recent months. The disinflation seen in falling headline inflation rates has been mostly driven by goods prices, whereas more wage sensitive services inflation remains high.
But despite near-term pressures, the ECB felt able to lower its estimate for core inflation in 2025 from 2.3% to 2.1% (marginally above the 2% target), prompting a rally in bonds. It soon evaporated during the press conference when President of the ECB, Christine Largarde, seemed to dampen expectations of an April hike on the basis there will be more data available by June.
This leaves markets expecting a quarter of a percentage point interest rate cut in the eurozone by June. Coincidentally, more or less the same is expected in the US. By December, it seems likely that both major central banks (the ECB and the Federal Reserve) will have cut most of a percentage point (but more likely in the eurozone).
Friday saw the release of the US labour market data for February, and it showed a labour market that is still strong. However, there were some weaker elements.
The headline is that jobs expanded, and wage growth slowed at just 0.1% over the month – this is the so-called ‘Goldilocks’ report, which is not too hot and not too cold. The Federal Reserve is watching wages like a hawk to gauge services inflation trends.
On the softer side, January’s bumper gain in payrolls was substantially revised lower and the unemployment rate rose to 3.9% from 3.7%, reflecting a curious discrepancy between the main payroll report (which surveys employers) and the unemployment report (which surveys employees). So, there’s probably enough here to keep interest rate expectations subdued going forwards, while providing hope that the short-term increase in monthly inflation will subside.
Japan
Japan, of course, bucks the trend with interest rates expected to rise, marginally, over the course of 2024. That assumption has been challenged by recent data, which have suggested that Japan is losing momentum, so it is particularly interesting that the same factor that is causing anxiety at the ECB (and presumably other central banks) is giving hope to the Bank of Japan (BoJ).
The 2024 spring wage negotiations (known as Shunto) are taking place between unions and employers. Anecdotal news suggests that unions are seeking substantial pay increases, well ahead of current inflation rates and notably ahead of those rates achieved at last year’s Shunto, too. The Japanese Trade Union Confederation (known as RENGO) suggests member unions will seek pay increases of 5.85%.
Recent weak economic data has been positive for Japanese equities by being negative for the yen. Japanese stocks outperform when the yen is weakening. Last week’s Shuntoõ news, coupled with a jump in Tokyo’s bellwether consumer price index (CPI) rate and better news on capital spending, boosted the yen but weighed on equity performance.
Budget week in the UK
The FTSE 100 underperformed last week as the pound rallied. This reflects a narrowing of anticipated interest rate spreads between the UK and the other major regions, partly aided by a more recent decline in UK inflation and some evidence of more persistent inflation elsewhere. Most of this seems likely to be explained by timing and the lagged impact of energy price inflation hitting the UK economy and subsequently ebbing due to the utility bills cap. The underlying factors driving inflation in the UK and Europe seem pretty similar.
The main economic event in the UK was the Spring Budget. Like the ECB meeting, this proved to be something of a non-event. Almost everything announced had been preannounced or leaked, ensuring a no-surprises budget, which contrasted with the infamous Liz Truss mini budget that spooked the markets so badly in late 2021.
The event passed off without incident, which is reassuring because with this being a (likely) election year, and with the government lagging in the polls, the incentive for fiscal largesse was high.
Fiscal rules
Recognising that chancellors can feel tempted by noneconomic motivations towards the end of electoral cycles, several safeguards have been put in place over the years. Gordon Brown became the UK’s first chancellor to employ fiscal rules. He was something of a trailblazer with versions of his golden rule being adopted by legislation throughout the core of Europe. George Osborne then added to the fiscal safeguards by instigating the Office for Budget Responsibility (OBR), an independent watchdog that forecasts the likely trajectory of government expenditure and the government against its self-imposed fiscal rules.
Sadly, the framework has not prevented the deterioration in public finances. Understandably, pressures such as the pandemic could not have been foreseen, however, when push comes to shove, the UK’s fiscal rules have been watered down rather than suffering the austerity they might hoist upon the electorate. Meanwhile, the OBR can only score the government’s fiscal plans, and those plans have invariably led to planned tax increases and spending cuts that are forever pushed back into a subsequent period. To its credit, the OBR has pointed out that it models on the basis of a fuel duty going up, despite the now established precedent of cancelling the fuel duty rise at each successive budget.
So, does spending and taxation carry on unchecked? Far from it. If the government is too profligate, the Bank of England will be forced to raise interest rates and it therefore acts as a stronger fiscal watchdog than the OBR. And, finally, the bond market and the pound would be the ultimate arbiter of fiscal policy, selling off if the government misbehaves.
So, what did happen? After much speculation, National Insurance was cut. This was in preference to a planned cut in the basic rate of income tax, which would have been more expensive to deliver. National Insurance is also only paid by employees rather than savers or pensioners. This helps the government justify a fiscal injection during a battle against inflation on the grounds it is encouraging people to enter the labour force.
The UK ISA
anticipated British ISA (although the government has chosen to brand it the UK ISA). The permitted investment would be £5,000, in addition to existing ISA entitlements. Further details were lacking, but according to the consultation document, it sounds as if the permitted investments would
be companies incorporated within the UK that are listed on a recognised index (LSE/AIM, Acquis and CBOE Europe), which means Cambridge-based ARM, would fail the listing rule (although a secondary listing in London might qualify).
We don’t know when the UK ISA will be available, but when Nigel Lawson introduced the personal equity plan in the 1986 budget, it was to be available from the following January.
Will it be enough to reinvigorate the UK’s flagging listings market? It seems unlikely. It would be irrational for anyone to invest in the UK ISA without first filling their normal ISA allowance of £20,000. As this would apply to relatively few people, it seems likely that UK ISAs will form a relatively modest part of the overall savings panoply and will not be enough to convince ARM that it should have listed back in London.
