An air of caution filtered throughout the equity markets on Tuesday with the FTSE 100 being the only real mover as the index continued its run above 7000. While strong performing mining stocks were seen as the catalyst driving the FTSE 100 higher. I would personally argue that the sudden resumption in Pound selling was the reason for the gains in the FTSE 100 yesterday. The FTSE 100 moved around 1% higher during trading with the Pound moving 1% lower against the dollar, as the FTSE 100 continues to mirror the movements of the British Pound.
The reason for the subdued trading atmosphere elsewhere could be due to the rising expectations of a U.S. interest rate rise leading to a risk-off environment. The ongoing reports that both the European Central Bank (ECB) and Bank of Japan (BoJ) have maxed out their ammunition when it comes to monetary stimulus has also likely had an impact on investor attraction with the equity markets having relied on easy money and an era of ultra-low interest rates for a significant period of time.
With U.S. interest rate expectations for December moving beyond 70% it does appear that the Federal Reserve have achieved success when it comes to preparing the financial markets for a US interest rate rise in the coming months. This has still not been fully priced into the financial markets, meaning that at the very least emerging market assets and precious metals will find themselves under further pressure if investor confidence over a probably U.S. interest rate increase in December gains additional momentum.
An unexpected Donald Trump victory in the U.S. Presidential election next month or a horrendous U.S. economic data release are currently seen as the only possible banana skin on the road to the Federal Reserve raising U.S. interest rates at the end of 2016.
Chinese yuan dominates headlines
The major headline throughout the financial world has been the Chinese Yuan falling to further milestone lows against the dollar. During the Chinese public holiday two weeks ago the Yuan moved past the psychological 6.70 level against the Dollar and there has been no stopping the selling momentum since. I personally feel at this point that the Dollar/Yuan will conclude the year with a move past 6.80, before gradually moving towards 7.
There are still different motives to expect further currency weakness for China at this point, with the most apparent reasons being increased inflation potential and to also encourage local consumers to spend within China’s own economy. It needs to be pointed out that the PBoC and Chinese government are still trying to rebalance the economy away from importing from others as it focuses towards building a stronger domestic economy and currency weakness would encourage a move in this direction.
While the further weakness in the Yuan is going to lead to attention towards possible capital outflows, there should not be any sudden panic about the new milestone lows at this point and this move in currency depreciation is far more gradual than the rapid depreciation seen in 2015.
What investors should instead focus towards is whether a correlation begins to emerge between Yuan weakness and stock market strength. We have seen this correlation emerge in the past with the Yen/Nikkei, Euro/Dax and more recently to date with the Pound/FTSE 100. If the outlook is for even further declines for the Yuan over the future, then it is possible that the Shanghai Composite Index will gain if the correlation emerges that we have seen elsewhere with other major currencies.
GBP/USD meets 1.20 once again
The selling in the British pound/U.S. dollar (GBP/USD) currency pair has also resumed with the Cable meeting 1.20 during trading yesterday. I don’t think there is any real surprise that the Cable resumed its fall as there are quite simply no buyers for the British Pound at this point, although the selling momentum did accelerate as BoE Governor Mark Carney testified to the House of Lords Economic Affairs Committee with questions hanging over his possible future.
I personally think that the recent criticism over the BoE has been unfair, and that speculation over central bank independence is that last thing the United Kingdom needs right now with investor uncertainty already at intense levels. The reason for the downfall in the British pound has had very little to do with the actions taken from the BoE, but are a direct consequence of the European Union referendum outcome and anxiety over the possibility that the United Kingdom could lose access to the EU single market.