US Interest Rates
The old saying that when America sneezes, Europe catches a cold may not be quite as true as it once was, since the emergence of China as the world’s second largest economy. However, a pullback in the world’s largest economy would still cause major problems for the FTSE 100 and, while the US continues to post relatively strong economic data, over the next few years things could change.
The major reason for this is the prospect of interest rate rises. Certainly, the FTSE 100 and S&P 500 have responded fairly positively to the end of the Federal Reserve’s monthly asset repurchase programme, but interest rate rises could be a different story. For starters, they could hurt market sentiment, as investors look back on a ‘once in a generation’ opportunity to invest while interest rates were near-zero and instead look forward to a long and arduous road back to normality (i.e. 4%-5% interest rates).
Furthermore, with US inflation still being below the Federal Reserve’s 2% target, interest rate rises could be viewed as pre-emptive and make the risk of deflation even greater. As such, an orderly interest rate rise may not be achievable.
Eurozone Problems
While the ECB has finally gone ahead with a programme of quantitative easing, there are no guarantees that it will work. After all, it still fails to address the imbalances that exist across Europe, with it likely to continue to be something of a two-speed economy, split between the north and the south.
And, with a Greek exit from the Euro still very much on the cards, things could get worse before they get better for the Eurozone. This would have a major impact upon the FTSE 100, since many of the index’s constituents are heavily reliant upon the region for their earnings, while investor sentiment could quickly change from optimism to fear if first Greece, and then possibly other countries, begin to exit the single currency.
General Election
Whether Mr. Cameron or Mr. Miliband occupies 10 Downing Street after next week, the future for the UK economy is likely to be very uncertain. If the former stays put, we are likely to have a period of time where there is the potential for the UK to exit the EU. This could cause a reduction in inward investment to the UK and also force investor sentiment to decline, thereby hurting the FTSE 100’s price level.
Similarly, if Mr. Miliband become Prime Minister, then the impact of his taxation and wealth distribution policies could be significant. For example, the mansion tax could cause a weakening of the housing market, less flexible labour laws could mean fewer jobs are created, while a general uncertainty among business leaders regarding his future policies on wealth redistribution via higher taxation could lead to lower levels of investment in training, plant and machinery. In turn, this could hurt the performance of the FTSE 100 over the medium term, as the UK becomes a less favourable place to invest.