Weekly Market Update

15/01/2018

So far, a positive start to the year as strong economic growth across most regions continues to be very supportive for global equities. While there appears to be no stopping the exuberance in equity markets, bond markets were not so lucky, with several events sparking investor concern.

One of the spurs for this sell-off in bonds was news that China might reduce or even stop its buying of US Treasury bonds. Although later denied, this comes at a time when the US Treasury is going to be in urgent need of cash to pay for President Donald Trump’s tax cuts.

A surprise move by the Bank of Japan to reduce the amount of bonds it buys every month under its stimulus programme also caused bond prices to fall. While this only amounts to small change, the hint of a tapering to stimulus was enough to create downward pressure on prices. The spike in bond yields reflected investors’ surprise at the Bank of Japan’s move and caused anxiety that they might be underestimating the pace at which central banks might look to withdraw stimulus in the coming months.

Politically, the week began with another awkward reshuffle of Theresa May’s cabinet. It ended with the news that Donald Trump would not be visiting the UK to open the new US embassy in London, in another sign of weakening UK/US relations.

Germany made progress on the political front with Angela Merkel’s party making a breakthrough in preliminary talks surrounding the formation of a coalition government with the Social Democrats. This could bring to an end to the stalemate that has persisted in German politics since last September’s inconclusive election. The euro rallied after the terms of the coalition deal emerged, reaching its highest level against the US dollar since January 2015.

A modest rise in US consumer prices in December and solid growth in retail sales bolstered expectations that inflation is firming, lifting expectations that the US Federal Reserve will raise rates as soon as March as rapid growth and low unemployment promise to boost prices. The consumer-price index rose just 0.1 per cent from November, but core prices jumped 0.3 per cent, the most in 11 months. Fed officials have pencilled in three rate increases this year, but this could increase to four given the strength of the economy and the added short-term impetus from deficit-expanding tax cuts.

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