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Economic Look Back on Q2 2017

Currency conundrum

Most investment returns for Irish investors are quoted in euro as we are a euro based economy. When we talk about ‘local currency’ however, we mean the stock market performance in the currency of a particular country. For example, the FTSE 100 in the UK might be +4% in Sterling or ‘local currency’ terms but only +2% in euro due to fluctuations in currency markets. Global stock markets in the second quarter of the year (in local currency terms) were broadly positive but euro-based investors (without currency protection) saw their returns impacted because of euro currency strength versus other major currencies. Changes in economic circumstance or political policy can significantly impact the relative strength or weakness of a currency and there were plenty of examples of both during the quarter. For example, global stock and currency markets reacted favourably to the election of Emmanuel Macron as French President. Conversely, continued political controversies in the U.S. have unsettled markets and the U.S. dollar on occasions. Similarly, the surprise outcome of the Brexit vote and the recent UK general election have not only possibly weakened the UK’s negotiating position with the EU but also their currency relative to the euro and other major currencies. At times like these, protecting investments against currency moves can make great sense and a big difference.

‘Hawks’ overhead

Policy makers who generally favour relatively high interest rates are known as ‘Hawks’ (‘Doves’ are the opposite) and appear to be wielding more influence across the world’s central banks. The U.S. Federal Reserve raised interest rates for a second time this year in June by 0.25% and indicated a total of three rate increases over 2017 and 2018. They also outlined plans to reduce the size of its balance sheet over the next four quarters – in other words, spending to support the economy. Even ECB President Mario Draghi hinted in late June at less policy ‘accommodation’ in the future. On the plus side it means there is both the evidence and confidence of a recovering global economy signalling the end of the need for historically low interest rates to support growth. In time it will also mean savers getting more for their money on deposit versus the near zero rates of return currently available. On the other side it means that borrowing costs are going to rise. Following the financial boom, some countries are still running with high levels of national and/or personal debt, including Ireland. That is a potentially dangerous combination threatening the recovery underway. Rising interest rates are likely to be a reality in the next 18 months, which is broadly a positive development but getting the timing and rate at which they rise correct is a difficult balancing act.

Trump trauma

The continued lack of clarity over the Trump administration’s policy agenda has been compounded by more political controversies in recent months around the firing of the head of the FBI, James Comey, the stuttering Republican healthcare bill and the rising noise about the relationship with Russia. We maintain a watching brief as a unique period in history unfolds.

Shares, bonds, commodities and currencies

The MSCI AC World equity index rose +3.3% over the second quarter of the year (in local currency terms) but fell -2.1% in euro (€). The U.S. was +3.1% (-3.3% in €), Eurozone was -0.1%, Emerging Markets +6.7% (-0.2% in €), Japan was +6.1% (-1.3% in €), the UK +0.8% (-1.8% in €), Pacific region was +1.2% (-4.7% in €). In bond markets, the Eurozone >5 year sovereign bond benchmark rose 0.8% over the quarter despite German 10 year bond yields strengthening to +0.47%. The euro was strong, rising from 1.065 to 1.1426 against the U.S. dollar as European political concerns eased, speculation over tighter ECB monetary policy and political controversies in the U.S. (which contributed to a weaker dollar). Commodities fell -5.4% (-11.4% in €) with oil falling -9.3% as inventory levels rose on the back of the continued rise in U.S. shale oil production and higher levels of oil production in Libya and Nigeria.