Alessandro #IoMiVaccino 🇮🇹🇪🇺🇺🇸🇮🇱 · @pelias01
29th Jul 2015 from TwitLonger
UK equities: what to do when rates rise
he market is pricing in a 80% probability of the first rate hike by February 2016 and a 30% probability by November 2015. The rates will rise in February, but sees a risk of a November rate hike. The probability of a November rate hike is higher than that implied by the market. The Governor of the Bank of England, Mark Carney, also noted recently that "the point at which interest rates may begin to rise is moving closer". There are some main risks as to why UK rates will rise earlier than expected:
While economic lead indicators have dipped, they still show an economy that is growing above trend
Composite PMI new orders are still consistent with 2.5% GDP growth. Vacancy growth has slowed slightly, but is still consistent with employment growth of 1.5%. With the rate of growth of the workforce being around 0.3%, that means that the unemployment rate should fall further. Part of the recent slowdown in employment growth can be attributed to the election period, with a number of industries (such as homebuilders) reporting that their plans were delayed in the run up to the election (with the latest employment data being the 3-month average up to May).
There appears limited spare capacity in the labour market...and labour is gaining pricing power
The employment ratio (i.e., the number of employed as a share of the population) is now the highest on record, in sharp contrast to, for example, the US. This means that there is less slack in the labour market. Indeed, Eurostat points out that only 9% of UK part-time workers want a full-time job (compared to 22% in Continental Europe).On several measures of capacity utilisation monitored by the BoE, the UK economy appears to be running above normal levels, while the OBR estimates that the output gap is just 0.5%. In addition, in the July REC survey, 96% of businesses said that they had 'no' or only 'a little' surplus capacity to accommodate any further increase in demand.
Less fiscal tightening than originally planned
Clearly the hope had been that fiscal policy - not monetary policy - would do the tightening. It was (and is) reasonable to expect the political and economic cycle to be coordinated with fiscal tightening (as happened in 2010 when fiscal policy was tightened in the first three years following the election and then ease in the run up to the elections). Initially, the UK budgeted for fiscal tightening of 3.5% of GDP in 2016-18 but, at the summer Budget, this was revised down to 2.6% of GDP.
The global cycle and the Fed
Global growth is recovering. Leading indicators such as PMIs are stabilising and the potentially destabilising shock of a Grexit has diminished. This has featured very strongly in the July MPC meeting, with members saying that "the uncertainty caused by recent developments in Greece was a very material factor in their decisions". As for the Fed, on three occasions, Yellen has signalled that she is looking to raise interest rates in 2015. Clearly the MPC would like to see the Fed move first, as has been the case in the majority of previous cycles (the BoE raised rates five months after the Fed on average, in previous tightening cycles). The Fed is expected to move in September.
Mortgage rates have been falling
To some extent we should recall, that rates have been falling over the past year, despite bond yields rising. Thus higher rates are needed just to return the mortgage rate to the position of a year ago. Monetary conditions have been tightening a little but are still below neutral despite both the strength of sterling and the rise in real rates (on the back of falling commodity prices).
Source: FxWire Pro - Commentary