Weekly Market Update

25/09/2017

A dramatic week with rhetoric between Kim Jong Un and Donald Trump accelerating, a historic move by the US Central Bank, major elections in Germany and a snap election called within Japan. This should have been enough to unnerve markets, but ultimately investors remained confident believing that economic fundamentals are improving.

The US Federal Reserve held interest rates but confirmed it would start reducing its balance sheet next month. This double announcement was largely anticipated and the move to a normalisation should be considered a positive one. The Fed was however, more aggressive than expected on the timing of rate rises and maintained its forecast of a further rate hike by the end of the year.

In terms of QE, the Fed has used the proceeds from maturing assets in its portfolio to buy more bonds. But this process will be scaled down from October onwards, with a small amount being allowed to roll off the balance sheet each month, with the aim to reduce their holdings to $3 trillion by 2021.

US retail sales and industrial production both came in well below consensus expectations in August, although a lot of that weakness resulted from the disruption caused by Hurricane Harvey. The number of Americans applying for unemployment benefits unexpectedly fell while the Philadelphia Federal Reserve’s business sentiment index rose to its highest level in three months, signalling further strength in the economy that could help bolster the Federal Reserve’s case for another rate rise this year.

The German Chancellor Angela Merkel secured her fourth term in office. This did not come as a surprise, of course, particularly considering the strength of the German economy. However, the process of forming a coalition could be more challenging following the populist rise, and with the Social Democrats pledging to forge an opposition party.

But the clear winners of the election were the right-wing AfD and the free-market FDP. Both parties more than doubled their share of the popular vote versus the last election, jumping over the 5 per cent threshold needed to secure representation in the next parliament. The next parliament will be represented by six parties, which complicates the formation of a new coalition government since none of those parties is close to the 50 per cent majority. In the longer-term, however, it could well increase the EU’s reluctance to make many concessions for fear of putting more wind in the populists’ sails.

In the UK, Moody’s rating agency downgraded the UK’s credit rating, stating that public finances are more stressed than the Treasury acknowledges and that the challenges of Brexit will increase risks to policymaking. The timing of the rating agency’s decision could not be more wounding for Theresa May, who hoped her speech in Florence, seeking to revive life back into the Brexit negotiations, would ease her political difficulties.

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