February's main theme was the rise in bond rates that caused a slowdown in the equities markets. A second notable trend was the increase in commodity prices.
Equity market trends: higher rates are spoiling the party
February seems to be a repeat of the previous month. Similarly to January, the past month got off to a flying start but ended up losing part of its advantage.
In the first half of February, the markets spiked: new records were reported in the US, eurozone stock markets resembled their pre-corona levels of February 2020 and, for the first time since 1990, the Japanese Nikkei 225 index reached the 30,000 point level. Performances of emerging markets were positive as well, although the Latin-American stock markets lagged. The stock markets were supported by the same themes as previously: optimism about reopening economies, fiscal and monetary support, and a favorable results season.
In the second half of the month, the rise in bond rates prompted investors to become more prudent given the rather high valuation levels of certain equity market segments. The increased bond rates prevented growth equities from maintaining their leading position. The rather bumpy sector rotation from growth to value equities that started in November was now quite noticeable in Europe and even more so in the US. Rising bond yields have a greater impact on the valuation of growth stocks than on lower valued stocks. This is because discounting future profits at a higher interest rate reduces present value, everything else being equal.
Bond market trends: rising rate trend continues
The American 10-year bond rate briefly rose above 1.5% at the end of February. This level had not been achieved since February of last year. The rise in 10-year rates stood at 40 basis points over the month and 100 basis points since the 0.5% low recorded in August. The rate hike was caused by rising inflation expectations. Several indicators pointed at some price pressure, such as the considerable fiscal support and increased delivery times. However, the rise in long rates of February was attributed to an increase in the real interest rate, as investors anticipated less loose monetary policy.
European bond rates partly followed the US trend in February (up to -0.25% for German rates). The appointment of Mario Draghi as the Prime Minister in Italy has been well perceived by the markets. For the first time since 2015, the Italian 10-year bond rate spread against German bonds dropped below 100 bps.
Corporate bond rates did not fully follow the rise of government bonds. This meant that, once again, the spreads of corporate bonds remained lower, both for investment-grade and high-yield segments. In both cases, they are now below their pre-corona levels of February 2020.
Central banks: only verbal intentions for the time being
Financial markets are closely following the comments of the central banks on the increased inflation expectations and on the rise in bond rates. The Federal Reserve highlighted that the US economy was still far from the Fed's targets for full employment and inflation. The rising bond rates were regarded as a sign of the market having confidence in a significant economic recovery.
Whereas, they appear to cause more worries at the European Central Bank. President Lagarde highlighted the importance of the market offering favorable funding terms. Chances are that the ECB will increase its bond purchases if bond rates would continue to rise. The Australian central bank on its side has already taken the step of higher bond purchases to limit interest rate rises.
Currencies: cyclic currencies are gaining ground
On balance, the dollar remained virtually unchanged against the euro in February, but the US currency briefly strengthened to 1.20 against a low of 1.235 in early January. The rise in (real) interest in dollars indicated support for the currency.
The British pound strengthened against the euro, now that the Brexit risk is over, and that rapid vaccinations give rise to hope for an imminent reopening of the economy. Moreover, the pound is a cyclical currency that often performs well when global growth expectations are improving.
Currencies that are sensitive to oil price developments (Norwegian krone, Russian ruble) and other commodity prices (Canadian and Australian dollar) performed well. The New-Zealand dollar also appreciated due to comments from the central bank which, given the high property prices, may indicate tightening monetary policy in the future.
Emerging markets currencies had a good start in February but subsequently lost their advantage. The central banks of several countries (emerging markets, but also others), announced their objectives to reduce the appreciation of their currencies against the dollar, by selling their currencies. They use this approach because the potential for further rate reductions is often limited.
Commodities: commodity prices are riding high
For the first time since January, the price for Brent oil rose to over 65 dollars per barrel. The optimism about the normalization of the economic activity - and the demand - was emphasized last month by the interruption in supply in the state of Texas. Due to the extreme winter weather, important parts of the production (approx. 4.6 million barrels per day in Texas) and refinery had to down tools. It is a temporary problem, but the recovery of the production could take several weeks. At the same time, the OPEC+ meeting of 4 March is anticipated, as it may announce easing of the production limitations, possibly by 1.5 million barrels per day from April. In the meantime, the discipline within OPEC+ for adhering to the production limitations remained strong.
The price of gold continued its downward trend to below 1,800 dollars per ounce. Contrary to the previous months, the rise in bond rates in the past month was not compensated by a continuing rise in inflation expectations. This resulted in the real interest - and therefore the opportunity costs of holding gold - rising sharply in February.
Industrial metal prices reported hikes across the entire spectrum in February. The cost price rose by as much as approx. 20% for the month, thus reaching its highest level in 10 years. In addition to the structural increase in demand, due to Chinese strong economy and the global need in the electrification of economies, purchases by investors, investing in real tangible assets