Sterling has been under renewed pressure since Theresa May said she would trigger article 50 by next March. At one point early on Friday morning, the pound traded as low as 1.1491 against the US dollar in very thin volumes before recovering to close the week at 1.2434, still a substantial decline from the prior Friday close of 1.2972. May has hinted at a “hard Brexit” with immigration controls being traded at the expense of remaining in the single market with all the short term negative consequences for the UK’s economic performance. Longer term, a weaker pound could put the UK in a competitive position to attract overseas investment, but for that to occur we will need to see a much weaker exchange rate than currently, even though sterling is trading at new 31-year lows. What is surprising is how UK investors do not seem to have taken the opportunity to invest in other currencies, particularly in Asia, to take advantage of the likely continued weakness in sterling in the months ahead.
Aside from sterling, the main focus last week was on September’s non-farm payroll data released on Friday. 156k jobs were added which was below expectations of +172k with the unemployment rate rising to 5% (versus expectations for 4.9%). For us, the key point is that US growth remains patchy and weak; the IMF cut its US growth forecast for 2016 to 1.6% from 2.2% and downgraded 2017 to 2.2%. In fact since the GFC US growth on an annual basis has been 2.5% or above in only 2 years one of which was 2015: this paled with the more buoyant decade or so pre-GFC. While indicators such as 2Q GDP have been revised up to 1.4% on a quarterly annualised basis and the September ISMs for both manufacturing and services showed improvement indicators such as the Chicago Fed National Activity Index, a broad based indicator of 85 economic variables, fell to -0.55 in August.
The IMF’s updated World Economic Outlook noted, ‘Some risks flagged in recent WEO reports have become more pronounced in recent months, including those associated with political discord and inward-looking policies, or secular stagnation in advanced economies. Other risks, such as rising financial turbulence and capital pullbacks from emerging market economies, seem to have become less prominent, but they still remain. On balance, downside risks continue to dominate.’ We would add negative demographic trends, disappointing productivity growth, rising inequality, weak business investment and high debt levels to a list of things to be concerned about.
A case in point would be Australia. In terms of rapidly increasing private debt, the IMF has singled out Australia, highlighting its increasing concerns over the country’s household debt. As regular readers know, Stratton Street’s Net Foreign Asset (NFA) calculations consider not only government debt but also corporate, and importantly, household liabilities. As such, Australia is not included in our investable universe as the country is assigned a 2 star rating; as NFL are greater than 50% of GDP.
Previously when high debt levels were of concern, world output and inflation were relatively strong, allowing debt to GDP ratios room to decline. Currently however we are faced with painfully slow global growth and benign inflation making these high debt levels, especially within the private sector appear even more concerning and unsustainable. Faced with this backdrop, central bank policy options will be highly constrained, with interest rates at very low levels for an extended period of time.
All this points to a continuation of the period of insipid growth and benign inflation, especially given the aging nature of the global population, particularly in the so-called “developed world”. Consequently, whilst we expect that the Fed will remain ahead of the curve and that any interest rate increases are likely to be extremely gradual; many of the forces that have been driving neutral rates to lower levels will remain entrenched anchoring interest rate expectations at the long-end of the curve where we favour positioning. We expect further flattening of the yield curve. High levels of uncertainty in global markets makes high quality bonds from creditors, particularly those offering positive yields, one of the most attractive places to be positioned.