World Economy

Falling Interest Rates Weigh on Markets

Fed funds futures market places a 22% chance of a rate hike in September.Fed funds futures market places a 22% chance of a rate hike in September.

Equities softened as disappointment over the European Central Bank’s decision to keep its monetary policy stance completely unchanged and uncertainty over the Federal Reserve’s interest rate trajectory weighed on markets.

The ECB left interest rates on its deposit facility at a record low of 0.4%, held its marginal lending rate at 0.25% and maintained a monthly asset purchase target of €80 billion ($89.9 billion), although many analysts expected the governing council to expand the duration of its QE program, Lloyds website reported.

A report showing that growth in the US service sector fell in August to the lowest since early 2010 initially weighed on sentiment, further hitting expectations for a US rate rise this month after disappointing non-farm payrolls data last week. The Institute for Supply Management’s non-manufacturing purchasing managers’ index dropped by more than expected to 51.4 in August from 55.5 the month before.

The poor economic news has caused investors to push back the expected timing of the next increase in borrowing costs by the Fed, with the Fed funds futures market placing a 22% chance of a rate hike in September, down from 36% a week ago. There is still more than a 50% chance of an increase in December, but the odds are also under pressure.

 Weak US Data

The weaker US data and softer dollar helped lift sterling, with the pound also bolstered by UK economic data that has largely been better than expected since the Brexit vote. A firmer pound, however, caused the FTSE 100 to underperform, as shares in foreign currency earners came under pressure.

UK manufacturing production continued to decline in July, the first full month after Britain’s vote to leave the EU, although overall industrial production, a broader gauge of the industry, rose 0.1%, against analysts’ expectations for a 0.2% decline.

Technical analysis of the FTSE 100 shows the blue-chip index has faltered since trading a double top at 6910, with a break of the 50-day moving average paving way for a short-term downward trend line. The declining oscillators reflect the dwindling momentum and have a little way to go before becoming oversold, suggesting the index may test historical support at 6610 and 6430 before building a new base.

In conclusion, the prospect of US borrowing costs staying near record lows for longer, supplemented by other global central banks easing monetary policy, have been underpinning stock market valuations and that is likely to remain the theme throughout the remainder of 2016. Near-term, however, the FTSE has gained over 20% since the referendum and the index has been long overdue a period of consolidation.