Surging U.S. markets, balance sheet normalization and potential UK rate hike

On today’s edition of Market Week in Review, Consulting Director Sophie Antal Gilbert chatted with Senior Investment Strategist Paul Eitelman about the recent rise in U.S. stocks and Treasury yields, what to expect at next week’s meeting of the U.S. Federal Reserve and the potential for tighter monetary policy in the UK.

U.S. markets climb after geopolitical worries, storm fears fade

Investor confidence picked back up in the U.S. after news surrounding North Korea and Hurricane Irma was not as bad as originally expected, Eitelman said, noting that the Chicago Board Options Exchange (CBOE) Volatility Index®—otherwise known as the fear index—also dropped this week. “The two big concerns investors had at this time last week were that North Korea might launch a ballistic missile on its national holiday (Sept. 9), and that Hurricane Irma could damage Miami, which is an important economic hub,” Eitelman said. Ultimately, the Sept. 9 missile launch didn’t happen, and the trajectory of Irma shifted further west, allowing Miami to avoid a direct hit. The net result? Good news for the U.S., Eitelman said, noting that equity markets bounced upward on Monday, setting the tone for the rest of the week. Case in point: On Friday, the S&P 500® Index was up roughly 1.5% from last week.

Yields on the 10-year U.S. Treasury note also rose this week—hitting 2.209% on Thursday, after dropping to 2.058% the previous week. Part of this upward move was the result of the better-than-expected news—“this allowed risk to creep back into the markets, with a flow shifting back from bonds to equities,” Eitelman said. In addition, U.S. inflation numbers for August came in stronger than expected, with the U.S. Bureau of Labor Statistics’ Consumer Price Index now up 1.9% year-over-year. This was very important news, Eitelman said, given that the U.S. had been stuck in a rut of disappointing inflation numbers for the past several months. “I guess the sixth time is the charm for inflation,” he quipped, adding that the country will still need to see more positive signs to re-establish a trend in the right direction.

Balance sheet normalization expected this week

Switching to the topic of next week’s U.S. Federal Reserve (the Fed) meeting, Eitelman noted that there are two important items on the agenda. First up is balance sheet normalization—the process by which the federal government shrinks the size of its balance sheet. The Fed is widely expected to announce the start of this next week, Eitelman said, noting that it laid out a very detailed plan for doing so back in June. “The key message here for investors is that this is very predictable—and should dampen any market volatility around the announcement,” he added.

The second item of importance, in Eitelman’s view, is whether or not a federal funds rate hike will occur this year. He and his team of strategists at Russell Investments are not expecting a hike in September, but there’s more uncertainty about how the Fed will act at its December meeting. “Our best sense from reading the tea leaves is that the Fed is completely split on whether or not to hike again,” Eitelman said. “We’re looking to next week’s meeting for more guidance as to how the Fed is feeling overall.”

Bank of England meeting signals potential rate hike

Shifting the conversation to the UK, Eitelman discussed the recent meeting of the Bank of England’s Monetary Policy Committee (MPC), which held off on an interest rate hike yesterday, but signaled that one may be in store soon. In Eitelman’s view, the bank is in a bit of a dilemma, with lots of uncertainty as to how Brexit might impact the local economy down the line. At the same time, there are plenty of current economic indicators supportive of a rate hike, such as inflation reaching a five-year high, a strong labor market and a low unemployment rate.

The consensus at yesterday’s meeting, Eitelman said, was that if economic conditions continue to improve, the bank will look to raise interest rates in the next couple months—potentially as soon as November. “This is a big shift from previous statements,” Eitelman remarked—“and the markets reacted to it.” After the announcement, he said, the British pound strengthened 3% against the U.S. dollar, which was a really big move from his vantage point. However, Eitelman cautioned, “even though markets shifted dramatically, I think it was more just a recalibration back to something that makes sense.” In short, Eitelman doesn’t expect much more volatility from the Bank of England going forward, but stressed that the situation bears watching.

Watch the video.