Markets tread water amid widespread uncertainty

Stock markets around the world are pausing for breath as they weigh up multiple uncertainties - the resignation of the UK’s Prime Minister, a fragile ceasefire in the Gulf, conflicting inflation and growth narratives and questions about the sustainability of the AI investment boom.

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All change in Downing Street - again

Just two Prime Ministers since the Second World War - Clement Attlee and Edward Heath - have entered and then left Downing Street as a consequence of a popular vote in a General Election. Sir Keir Starmer will not join them, after announcing this morning that he, too, will leave his post earlier than he wanted.

After a weekend of reflection at Chequers, he admitted defeat, accepting the judgement of his MPs that he is not the leader to fight off the threat from Reform UK at the next election. He announced a short timetable for a replacement that will see a seventh Prime Minister in a decade in place by Parliament’s summer recess.

That replacement is widely expected to be Andy Burnham, who won a convincing by-election victory in Makerfield last week, enabling him to stand against Starmer. With rival Wes Streeting quickly backing Burnham after Starmer’s resignation speech, the path is in place for a ‘coronation’ rather than a leadership contest. Burnham is viewed by Labour MPs as the best defence against Reform.

From a market perspective, there was only a muted reaction to the news, which surprised no-one. The FTSE 100 was broadly flat, 10-year bond yields rose by a modest 11 basis points to 4.85%, and the pound drifted only a little to $1.32.

Although there has been speculation that a Burnham-led government will drift to the left in fiscal policy terms, markets are resisting judgement for now until there is more clarity about what the new-look government might offer in practice.

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Meanwhile, beyond the Westminster bubble…

While the changes in Downing Street are of great interest here in the UK, the rest of the world is more concerned about the fragile truce still just about holding in the Gulf. Despite threats over the weekend from Iran that it could re-close the Strait of Hormuz following continued fighting between Israel and the Hizbollah militia it supports in Lebanon, talks continue in Switzerland with the US to turn a memorandum of understanding and a ceasefire extension into something more like a permanent solution to the war that began nearly four months ago.

The oil price responded positively to the ongoing talks, with Brent crude slipping below $80 a barrel after an 8% slide last week. Investors have continued to view the war in the Gulf as a temporary break in the supply of oil to the global economy. Although the war has gone on much longer than expected when hostilities broke out in February, long term oil price expectations have remained contained.

Divergent central banks

The oil price matters because of its significant impact on the rate of inflation, which has remained above target for several years since the Covid pandemic, muddying the waters for central banks tasked with balancing control of inflation with support for economic growth.

Increasingly, those central banks are diverging in their approaches, with rate-setting meetings last week seeing the Federal Reserve and Bank of England holding fire, while those in Europe and Japan raised rates by a quarter of a percentage point.

The Fed’s meeting was the first under new chair Kevin Warsh. Although rates were left unchanged, the mood music was decisively hawkish as the fight against inflation was repeatedly emphasised by Jerome Powell’s replacement.

AI boom holds - for now

Meanwhile, the principal driver of share prices continues to be the boom in tech shares, in particular those linked to the surge in AI-related infrastructure investment. Soaring share prices for memory stocks like SK Hynix and Samsung in Korea and semiconductor stocks like Taiwan Semiconductor Manufacturing have disguised more tepid gains in the rest of the stock market.

To a large extent the AI boom has been justified by surging earnings at these companies. But with doubts about the returns that can be achieved on investments worth hundreds of billions of dollars, together with a rising challenge to equity investors from rising bond yields, more equity issuance and fewer share buybacks, the boom feels fragile.

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