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Investment Desk Analyst

October showed fairly sizeable movements on the equity, fixed-income and foreign exchange markets. Once again, central bank activity had a lot to do with this. Our expert, Johan Gallopyn, outlines the main trends of the past month.

Equity markets

European equity markets were lacking in direction pending the announcement by the European Central Bank relating to a slowdown in its bond purchase programme. After the ECB meeting, market prices rose briskly since no stricter position than expected on future monetary policy was detected. The German DAX index reached a new all-time high, while the CAC40 hit 5,500 points, the highest level since January 2008. Given the political tension surrounding the situation in Catalonia, the Spanish stock market did not follow the positive trend. Needless to say US shares once again broke new records, with markets being buoyed by the publication of figures for the third quarter. In the US more than half of businesses had already reported on profits by the end of October, and these were up 4.7% on the previous year. This is better than the admittedly low forecast at the start of the reporting season. In Europe, profit growth clocked in at around 8%, although fewer businesses in Europe led to a positive surprise (52%) than in the US (79%). Asian markets performed very well in view of good company results and the convincing election victory in Japan of incumbent Prime Minister Abe (MSCI Japan +6,2%). This means that the current economic reform programme can continue, and that Haruhiko Kuroda is likely to be reappointed next year as Chairman of the Bank of Japan.

 

Bond markets

The US bond rate continued in line with September’s upward trend, with the 10-year bond yield closing above 2.40%. The economic figures surprised in a positive way, except for inflation figures, making the expected rate increase in December virtually certain. In Europe, the ECB was the prime instigator of movements on the bond markets: confirmation that the central bank will still remain active in the market next year made rates fall once more. For example, the German 10-year bond rate closed 10 basis points lower below 0.40%. The rates of the peripheral countries followed this trend, including the Spanish bond rates, which experienced only brief turbulence stemming from Catalonia’s declaration of independence. Italian and Portuguese bond rates fell considerably lower, as both benefit from the ECB’s announcement. Portuguese bonds also became more attractive following a rating upgrade in September. In Italy, Parliament adopted a reform of electoral law that will make it more difficult for the anti-establishment and Eurosceptic Five-Star movement to gain a majority. Italian bonds were also helped by S&P’s credit rating upgrade. As far as corporate bonds are concerned spreads went down across the board, also as a result of the announcement by the ECB which also purchases corporate bonds as part of its purchase programme. Non-financial issuers reached the lowest spread in the past 10 years.

 

Central banks and monetary policy

Over the past few months, the financial markets were being prepared for an announcement on 26 October of the start of the cutback of the bond purchase programme. Here, the European Central Bank indeed acted entirely as expected. Starting in January 2018, the ECB will reduce its bond purchases from 60 billion euros per month to 30 billion euros per month. That rate will apply until September. Nevertheless, the central bank clearly indicated that an extension beyond that date - as well as an increase in the amount - cannot be ruled out if it proves necessary. In fact, support is unlikely to be withdrawn altogether after September 2018. The ECB also confirmed that a first rate increase in the euro zone is only to be expected some time after the purchase programme has come to an end, in other words at some point in 2019. In the United States, attention focused primarily on the appointment of a new Chair of the Federal Reserve following the expiry of Janet Yellen’s term early next year. At the end of last month the choice seemed to be between Jerome Powell, who may be regarded as the candidate of continuity, and John Taylor, who will probably steer a rather stricter course.

 

Currencies

The euro lost ground against most currencies after the ECB announced the reduction of its bond purchase programme. The market response to that ‘mild’ message brought a new downturn in European bond rates and consequently a wider divergence in rate levels between Europe and the United States. With the increased rate advantage for US bonds, the USD is seen by investors as becoming more attractive. Pound sterling was able to consolidate its gain of September as a stronger-than-expected growth figure for the third quarter and higher inflation (3.0%) make an interest rate rise this month more likely. The Scandinavian currencies (SEK and NOK) lost some ground (both -1.2%) after the central banks of those countries left interest rates unchanged as expected and made very cautious statements about future monetary policy. The idea behind this is not to raise any expectations that diverge too much from the ECB’s projections as that would cause an unwanted appreciation of their currencies. The New Zealand dollar lost ground (-4.2% against the euro) after the September elections brought about a government involving an unlikely coalition of Labour and the New Zealand First party. The Australian dollar fell (-1.0% against the euro) in response to a lower-than-expected inflation figure.

 

Commodities

Oil prices topped the USD 60/barrel mark for the first time since July 2015. OPEC and Russia are reportedly in favour of extending production restrictions - which now run until March 2018 - to the end of 2018, the idea being to bring down the still-high stocks of crude oil to an average level. Prices of industrial metals continued to rise, despite the stronger dollar, while copper, nickel and aluminium reached their highest levels since 2015 or even further back. The price of gold, on the other hand, declined (-1,1% in USD)  in a context with few factors to support it: interest rate outlook, stronger dollar, limited need for safe haven investments, etc.

 

 

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