With economic data in the US and the UK moving positively forward slightly this week, James Klempster discusses what this tells us about the medium term outlook.
Hello it's Friday, 4th October. I thought we'd pause for a few moments and reflect on what's been going on in markets this week. The biggest news story, of course, is the conflict in the Middle East and, most notably, the potential for escalation of an increased level of uncertainty around that region. And we've seen an increase in the implied volatility index, the VIX index, the so-called Wall Street fear gauge, although not back to the levels we saw it spiked to at the start of August. Alongside that small equity sell-off, which we've seen this week, a handful of a percent off in most major markets, we've seen, generally speaking, government bond yields come down. There has been a slight sell-off in equity, and a commensurate increase in the price of government bonds, because bond prices are inversely related to yields. And so you're seeing that diversification benefit that we often talk about really coming through, even over the short-term, over the course of this week.
The impact on oil prices
I think the most notable move probably, and the one you'll read about a lot, is in the oil price. The Brent crude, which is the main global oil benchmark, went up to $77 a barrel. And the increase over the last few trading days has been the steepest increase we've seen in about 18 months. There's a lot of concern about the pass through to inflation that may cause. The reason for the increase in the oil price is there's some belief that wasn't totally quashed by Joe Biden during the week that Israel could target Iran's oil production. And clearly if you have a reduction in supply, that will create a supply and demand imbalance. That's why you're seeing the price of oil go up.
However, it's worth putting it into some context though. In September oil prices had got pretty low. You may have felt it as you filled the car up. So, the price has now returned to around $77 a barrel. While it's a substantial move from the September lows, we're still below the levels we saw in 2022 and 2023 and indeed most of 2024. So, the increase is there and mathematically it will have an impact on inflation. Again, if you fill the car up at the weekend, you'll likely see the difference. But I think we've got to remain aware of the bigger picture, which is that the price of oil has increased, but is still below the levels which we've become accustomed to in the last few years.
On the subject of geopolitics, it is one of our themes that we refer to when we are thinking about the longer-term prospects of inflation being higher, but not necessarily high. You know it produces or will likely produce friction in the global economy, which creates inefficiencies and inefficiencies can lead to an underlying background inflationary increase, not necessarily a big spike, but an elevated level of background inflation, which we think will be a feature of the global economy going forward from here.
Another element of that is the green transition. We saw some good news in the UK this week on that note. We saw the end of coal fired energy production, and we were the first G7 economy to do that, demonstrating firstly that the green transition is taking place. But it is also a good news story for the UK for a change. We're sort of at the vanguard of that and it is something to reflect on. The inflationary impact will be not material in the short-term, but on the subject of UK inflation and central bank policy, we had the Bank of England Governor Andrew Bailey talking this week about whether it could be a bit more activist in terms of its monetary policy approach – this is in light of inflation generally coming down around the world. This was an interesting comment in the context of the fact that we had a decision to sit on our hands and not move interest rates last time the Bank of England Monetary Policy Committee met, having moved down 25 basis points before then. Between then and now we've had the bumper rate cut from the US, that 50 basis point move down. And so, in some ways, it looks almost like the Bank of England is copying the Fed's homework. But I suppose what it does show is the openness of central bankers to move materially if they don't see the inflation risks that they had perceived to be there even a few months ago.
To sum up
We've seen some sell-offs in equity markets and some more positive moves in government bonds as a result of those yields coming down. But we have to refer to China as well. We had the big stimulus package out of China last week. we reflected on it in the last video, and we’ve seen continued buoyancy in the Chinese stock market at the start of this week. It's been closed for the last couple of days, but over five trading days or so, the Chinese stock market is up about 25%. It's in a bull market on the back of that significant commitment from the Chinese government to get the economy rolling again.
And it also demonstrates the importance of sentiment and the power of net buyers rather than being in a net sell position, how quickly that inflow of capital can push asset prices up and move an equity market up very substantially from a relatively under bought level. If we take a step back, this highlights the importance and the value to us of being diversified in portfolios. You've got a week where risk aversion has increased. We've seen stock markets sell-off. But even within the global stock market as a whole, there are pockets of positivity – such as the Chinese stock market and also sectors and styles that will continue to be going up in value even when the broad thrust of markets is down. And at the same time, of course, diversification coming through from your fixed income elements as well. That's why we believe very firmly in creating broadly diversified portfolios with lots of different returns drivers. Because if you have too much sensitivity to any one factor, you can have too much idiosyncratic risk, too much focused risk being pulled into your portfolio.
That's it from me. Have a good weekend when you get there and we'll see you next time.
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