Financial assets made broad-based gains in February. The S&P 500 reached a new all-time high closing up 85 at 2,363 while the narrowly based Dow Jones gained nearly 5%. The FTSE100 and Eurofirst 300 indices rose similar amounts in local currency terms adding 164 and 38 to close at 7,263 and 1,458 respectively. For UK based investors, global continues to out-perform local; Asian and emerging markets, helped by sterling weakness against the dollar, were the best performers bringing their year-to-date return to 7%-8%. Smaller gains on the Nikkei 225 saw the index close at 19,119. Following the sharp sell-off in January, fixed interest re-connected with equities as European bond yields fell with UK 10 year yields down 27bp to 1.15%. Lower yields were somewhat at odds with inflation at mutli-year highs in the advanced economies and US and UK unemployment approaching cyclical lows.
The UK Budget will be delivered against a backdrop of better than expected economic growth and stronger government finances. The latter have been driven by a higher than anticipated 5.5% rise in tax receipts which more than covers the planned 2% spending increase. Faced with Brexit uncertainty, the Chancellor is likely to divide the spoils between a prudent reduction in the deficit – as the economy needs little extra stimulus – and support for government priorities such as infrastructure and housing as well as some relief for the relentless pressures on social care and the NHS. The stronger fiscal position and faster than expected reduction in the deficit will impact UK gilts. Over-funding in 2016/17 suggests issuance in 2017/18 may be the lowest since the financial crisis which would help offset the phasing out of quantitative easing and in the process restrain upward pressure on yields.
Economic data continues to surprise modestly on the upside as the recovery in economic activity picks up. The OECD Leading Indicator suggests global growth could enter another mini-expansion phase for the third time since the financial crisis with GDP of 2.8% this year and 3.2% in 2018. The fastest rate of improvement is in the UK, Eurozone and Russia – all of which now exceed the US and China. Although the US expansion is comparatively mature, there are few signs of the stresses associated with an end to the cycle. President Trump’s fiscal policies – even if watered down by practical considerations – are expected to boost GDP growth by at least 25bp per annum over the next two years. Eurozone expansion is only just gathering momentum and, while the region faces a number of structural challenges as well as political uncertainty, it still has plenty of scope to perform. The potential dampener on global growth comes from the largest contributor – China – which, having surprised on the upside in 2016, faces tighter monetary policy to dampen property speculation. Other developing economies have different sensitivities to the global cycle so, for example, its very young demographic profile means India is likely to continue growing at an above average rate of 7%-8%.
Headline inflation should reach an inflection point in the coming months as the impact of the year-on-year change in energy prices dissipates. Core inflation is nudging up but wage growth is generally well contained and consumer inflation expectations are subdued. However, with 10 year bond yields well below nominal GDP, the retreating disinflationary threat should enable central banks to adjust monetary policy and normalise interest rates. In the past few weeks several Federal Reserve governors have indicated that US rates will rise again
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