Monday 22/07/2019

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Investment Desk Analyst

European equities performed very well in April, and are again in positive territory as from the start of this year. The American bond rate climbed to 3%. Our expert Johan Gallopyn looks at the main events of the past month for equity, bond and foreign exchange markets.

Equity markets

Equities performed very well in the month of April, and the Eurozone (MSCI EMU +4.9%) outperformed other regions. As a result, the bulk of the equity markets have re-emerged on positive ground since the beginning of this year. Valuations and the dollar’s appreciation worked to the advantage of European equities. US equities lagged somewhat behind last month, as the 10 year bond yield hit the 3% level. Despite it only being a symbolic threshold, it does influence the relative valuation of US equities compared to bonds. It is also partially the reason why the outstanding earnings season in the US has only resulted in a rather moderate response on the stock market. For the S&P500 companies, the earnings already published at the end of April are no less than 23% higher than for the first quarter of the previous year. Should this trend continue, it will result in the most robust earnings growth in 10 years. The solid performance is attributable to the tax reduction’s impact, for the first time tangible in the first quarter, but it can also be ascribed to robust economic growth. The reported turnover also exceeded expectations. In Europe too, the figures beat expectations albeit less pronounced than the US results. Overall the performance in the Emerging Markets was less impressive due to the stronger dollar. Although the Asian region (MSCI EM Asia +0.1% in euros) was just able to keep its head above water, the Eastern European region (MSCI EM Eastern Europe -4.8% in euros) was forced to take a substantial step backwards as a result of a decline in Russian equities and currency.

 

Bond markets

In April, the US 10-year interest rate briefly rose above 3%. Since the beginning of this year, the long-term interest rate has already increased by 55 basis points. Due to signs of a more rapid increase in the underlying inflation than expected, the markets have come to expect quicker acceleration in the upsurge of short-term interest rates. The European interest rate is not following this trend. In April the 10-year German interest rate only rose by 6 basis points, and since the beginning of this year, the interest rate has still only gone up by 13 basis points. The disparate growth momentum and the resulting expectations vis-a-vis monetary policy can be seen as key drivers of this divergence. Bonds in the periphery continue to perform well. Compared to German bonds, the Italian spreads continued to decline even further, regardless of the political deadlock in which Italy has found itself. Two months after the election, there has been no progress to produce a government. A possible scenario involving post-summer elections cannot be excluded. Corporate bonds saw a renewed decline in spreads, thereby cancelling out part of the previous month’s movement.

 

 
Central banks and monetary policy

In its most recent meeting, the European Central Bank acknowledged that the European economy is going through a period of slower growth; however, it pointed out that this may partially be attributable to temporary factors. It retained confidence that inflation will evolve toward its 2% target. As a result, prospects in terms of monetary policy remain unchanged; however, ECB President Draghi’s cautious phrasing may serve as an indication that the ECB will only provide insight a month later than forecast (July instead of June) on how the bond purchase programme is set to evolve after the month of September. Following the economic figures indicating increasing price pressure in the US, the market assumes that the Federal Reserve will remain relatively hawkish in its comments on future monetary policy. Based on the Fed Fund futures, the probability of three additional interest rate hikes this year is estimated at nearly 50%, compared to the just 30% a month ago. The market expects a new interest rate increase in June. The Bank of England faced disappointing economic figures in recent weeks, in terms of both inflation and growth. As a result, an increase in the short term interest rate in May has become doubtful.

 

Currencies

The USD is eventually benefiting from the interest advantage that the currency offers compared with most other major currencies. Against the EUR, the 1.20 level was back in sight by the end of the month. In the US an increasing number of indicators point to intensifying pressure on wages, which will potentially speed up the pace of the Fed’s rate hikes. In contrast, the recent decline in economic growth in the Eurozone will cause the ECB to urge even more caution against rushing toward normalisation of monetary policy. That said, we did not see euro weakness in April. The British pound lost part of its gain against the euro last month following disappointing growth figures, which makes an increase in the interest rate this month less likely. The Swiss franc also declined to 1.20 and in doing so reached the level prior to January 2015 when Switzerland unpegged the Swiss franc from the euro. The Swedish krona was again forced to concede ground (-3.0% against the EUR in April), causing the loss since the beginning of this year to amount to 7.7%. The Swedish Central Bank remains very cautious against a background of low inflation and a cooling housing market, and has again postponed expectations of an increase in the interest rate to the year’s end.

 


Commodities

The Brent oil price briefly reached the USD 75 per barrel threshold, the highest level since the end of 2014. Oil reserves are gradually returning to their long-term average as a result of the strong demand caused by worldwide economic growth and OPEC and Russia’s output restrictions. In addition, it increasingly appears that the US will end its nuclear deal with Iran, which has the potential to lead to a renewed upsurge in the region’s instability. In terms of industrial metals, there were some striking fluctuations in the price of aluminium. The price rose from USD 2,000 to 2,600 per tonne, closing the month at around USD 2,250 per tonne. This volatility is the consequence of the economic sanctions announced by the US against Russia in response to the conflict in Syria, and which also pertains to one of the largest aluminium manufacturers in the world, the Russian company Rusal. Prices for other industrial metals were mixed. The price of gold dropped back to around USD 1,300 dollar per ounce, especially towards the end of the month. The stronger USD in particular, but also the rising interest rate in the US along with the moderation in geopolitical tensions have led to a decline in the appeal of precious metals.

 

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