On Wednesday this week, the FTSE 100 Index fell 3.2%, the highest single day fall for three years. This coincided with Boris Johnson's big speech at the Conservative Party conference and his latest proposal for a Brexit deal. Movements with regard to Brexit are usually felt most acutely in the foreign exchange market, with the pound typically falling on the prospect of a "no deal", and rising when a deal looks promising. Yesterday, however, the pound was little moved against both the US dollar and the euro, suggesting that the fall in the FTSE 100 has been driven by factors outside of Brexit.
Outside of the UK, this week has seen the S&P 500 fall 3%, with similar falls also occurring in European equity markets. The fall in markets appears to have been caused by weaker than expected US economic data, particularly from the manufacturing sector. The ISM* Manufacturing PMI** survey fell to 47.8, the lowest level since 2009, implying a contraction in the sector. There was further bad news on the trade front, with a World Trade Organisation ruling that allows the US to impose tariffs on European goods in response to subsidies granted to the European Aerospace industry. This case goes back to 2004 and will allow tariffs to be applied to a wide range of European goods from the 18th of October 2019. An escalation of tariffs will not help global trade, and presents additional concerns to manufacturers on both sides of the Atlantic.
President Trump continues to blame the weak data on the Federal Reserve (Fed) not cutting rates by enough and the relative strength of the dollar. On a trade weighted basis, the dollar is up only 1% this year, and is almost unchanged from where it was three years ago prior to Trump's election.
The Fed has cut rates twice in the last three months, and one more cut is expected by the end of the year. However, unemployment has been low and so far the US consumer has remained resilient. The cuts can be seen as a response to the impact of US trade policy, rather than a contributor to the slowing economy. If anything, by cutting rates the Fed has acted before the economy gets any worse. As a result of lower rate expectations, bonds have rallied and lower long-term yields make equity markets look relatively more attractive.
October has often been a bad month for markets with participants happy to lock-in gains, and with the S&P 500 up over 18% in the first nine months of the year, so far this year is no exception. This can add to volatility and may create a buying opportunity in due course. Trump is in a position to agree a trade deal with China and compromise with Europe, which would support a recovery from this week's falls. However, the impeachment investigation may be a distraction and may make passing legislation on spending more difficult in the months to come. On Brexit, the news changes by the minute and Boris Johnson's latest proposal may be the basis of a compromise that could get parliamentary approval, but initial noise from Europe does not sound promising. The threat that it is either his deal or no deal appears hollow, with Parliament determined to block a no deal. As a result, however cheap the UK may look, with the FTSE 100 dividend yield at 5.16% against ten-year gilts yielding 0.46%, investors appear still reluctant to buy while the Brexit uncertainty remains.
While Brexit bears on the minds of UK investors, it continues to be US trade policy that has been having the greater impact on markets. Thus our eyes will remain on the White House as much as, if not more than, Whitehall.
*The Institue for Supply Management (ISM)
**Manufacturing Purchasing Managers' Index (PMI)
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