Reflecting on July 2019
WHAT HAS HAPPENED?
July was a relatively quiet month for financial markets. Corporate earnings season kicked off in earnest but in aggregate provided few surprises as investors had their sights fixed on the US Federal Reserve meeting which took place on the last day of the month. Most developed equity market indices posted modest gains, with the FTSE 100 up 2.2% and amongst the better performers as the decline in sterling provided support to those constituents with significant non-sterling revenues. In the US, the S&P 500 Index gained 1.3%, slightly more than the Dow Jones Industrial Average which rose 1.0%, while the MSCI World posted gains of 0.4%.
WHY?
Monetary policy, alongside the US / China trade dispute, has arguably been the predominant driver of financial markets over the last 12 months. The weakness in equity markets during the second half of 2018 came about as the US Federal Reserve seemed committed to a steady path of interest rate hikes, and their recovery has come as the Fed has changed course over the last seven months. Government bonds have also rallied over that period, with 10-year yields on US, UK and German debt significantly lower than they were at the beginning of the year. Therefore, with monetary policy playing such an important role in the direction of a number of asset classes, market participants were to some extent in wait and see mode during July in anticipation of the Fed’s meeting.
WHAT SHOULD YOU TAKE AWAY FROM IT?
The Fed met market expectations by lowering interest rates by 25bps at its meeting on 31st July. However, equity markets were disappointed by the relative hawkishness of Chair Jay Powell’s comments in his press conference that followed the decision. With the markets expecting a further two rate cuts by the end of the year in addition to the one just announced by the Fed, Powell failed to commit to a new cycle of monetary policy easing, describing the Federal Open Market Committee’s strategy as a “mid-cycle adjustment to policy”.
The reaction in the bond market was for the yield curve to flatten – that is for longer-dated yields to fall further than shorter dated ones. The spread (difference) between the US 2-year and 10-year treasury yields is now just 15bps, with the strength in the longer-dated government bonds suggesting that the Fed’s efforts are insufficient to prevent a deterioration in the US economic outlook.
Will the Fed follow its July rate cut with more before the end of the year? The market continues to think so with a 96% chance, based on the interest rate futures, of a further cut in September and a 70% chance of what would be a third for the year before the end of December.
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