Lessons from the second quarter
William Hobbs, Barclays’ Head of Investment Strategy for the UK and Europe, reviews the markets during the second quarter of 2018, including rising interest rates and the political scene in Italy.
What you’ll learn:Click to toggle accordion What you’ll learn:
How rising US interest rates expose countries which have been living beyond their means.
Which markets are proving resilient to rising interest rates.
Why higher interest rates are important in enforcing discipline and restraint.
Like it or not, higher interest rates are coming. Savers may welcome them, but higher interest rates are far from universally popular. As interest rates rise, everything from the decision to splash out on some ‘Paw Patrol’ plastic to placate the little savages to state infrastructure projects needs to be re-evaluated.
Higher interest rates also change the complexion of past projects too. Populist political leaders therefore tend to be on fertile ground railing against them - Turkish President Tayyip Erdogan recently described higher interest rates as the “mother and father of all evil”, adding to his previous (extraordinary) suggestion that higher interest rates actually cause higher inflation.
Whatever your views on higher interest rates, this was a quarter when they did us all a few favours.
When the tide goes out...
It is precisely because the act of raising interest rates is more often than not going to be unpopular, that central banking has been taken away from politicians in most of the world’s major economies. Independent, unpopular, central banking is rightly cherished by investors, as the recent flare up in Turkey proved. President Erdogan’s promise to step up his role in the economy after elections at the end of June was not well received by markets. The lira plunged, borrowing costs soared, and the country gazed briefly into the economic abyss. In response, the central bank, against earlier ‘advice’ from the President, has raised interest rates by a cumulative 5%. Disaster seems to have been averted for now, with some trust restored in the inflation-fighting credibility of the Turkish central bank.
Other countries around the world have also been using the ultra-low interest rates of the post-crisis era to live beyond their means, or swim without their trunks, as the saying goes. Such swimmers are always easier to spot when the tide goes out, or when interest rates rise as they are doing in the US at the moment.
However, using a scorecard that focuses on factors ranging from external funding needs and debt exposures, to the ability to attract foreign investment flows, we’ve found that the sinners seem relatively isolated amongst the emerging market economies in the current cycle. Argentina, Turkey and South Africa stand out. Reassuringly, emerging Asia, where we remain most positive within emerging markets, appears to be most resilient to rising US interest rates on this measure.
Italy has also hit the headlines in the second quarter. Some wild statements on spending plans, debt forgiveness and even euro membership, from the incoming Italian government saw borrowing costs in the economy understandably spike. Watch your mortgage advisor’s face as you suggest that you are going to work less, spend more, and may want to pay your mortgage back in a ‘new’ currency.
However, a few days of rising panic in markets served to blunt some of the new coalition’s proposals. A new, less incendiary finance minister was proposed and reassurances were given on EU membership among other things. Markets calmed again. As it goes, this disciplinary streak in markets may also come in handy in the UK before too long.
These examples of living beyond means, or trying to, will not be limited to specific countries. As always, there will be lenders and borrowers all over the world who have misjudged. As the cost of borrowing in the US continues to rise, more of these incidences will no doubt be revealed.
However, our bet remains that the scale and systemic importance of these misjudgements is not yet sufficient to threaten the economic cycle. Risk appetite has been understandably constrained for much of the last decade. The Great Financial Crisis of 2007/08, and indeed the still-smouldering Euro Crisis have cast a long shadow over the appetite to borrow among consumers and businesses.
That shadow has started to fade in the last couple of years. Those ready to borrow are finally meeting banks ready and more able to lend. Higher interest rates will be important in enforcing some discipline and restraint.
Rising interest rates complicate the job of stock market investing, particularly for those looking for less risk. The role of large chunks of the high-quality government and corporate bond market will continue to appeal as more of a diversifier within a portfolio, rather than a way to generate strong returns for a while yet.
Remember, the value of investments can fall as well as rise and you could get back less than you invest. We're not recommending Ready-made Investments as being suitable for you based on your personal circumstances. If you're unsure about this investment’s suitability for you, you should seek independent advice.
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