Monthly Market News
May was an eventful month. It was not only the Italian political crisis that affected the equity, bond and foreign exchange markets. Our expert, Johan Gallopyn, outlines the main events of the past month.
Equities had a strong start in the month of May. The markets continued the trend of April, supported by strong corporate profits in the first quarter. However, already then there were events that led to volatility, notably the US withdrawal from the nuclear deal with Iran and whether or not the talks between President Trump and the North Korean leader Kim Jong-un would go ahead. Only in the second half of the month the investor sentiment soured when it became clear that Italy was heading for a populist government that would come into conflict with “Europe”. The resulting risk aversion and the stronger USD made the European stock market the least performing region of the month. Less surprisingly, Italian equities performed even worse, with the outperformance against the European market in general since the beginning of the year was as good as lost. The emerging markets also experienced a weak month, with the Latin American region in particular suffering a sharp decline due to the economic problems in Argentina and Brazil. MSCI Latin America fell 14.1% in euro terms. At the very end of the month, the US decided not to extend the exemption from import duties on aluminium and steel granted to Europe, Canada and Mexico earlier this year. This once again brought to the fore the fear of an escalating trade conflict.
In the past month, the most striking evolution took place in the bond markets. This, of course, was due to the uncertainty caused by the numerous plot twists in the formation of the government in Italy and the possible consequences of the Five Star Movement and Lega coalition. The implementation of the government programme will lead to an increase in the debt ratio and the Euro-critical positions of both parties are viewed with suspicion, even if they do not materialise in the government programme. The 10-year interest rate on Italian government bonds increased in one month from 1.8% to 3%. The interest rate on German bonds - safe haven in uncertain times - fell from 0.6% to 0.3%. The other periphery countries were hit, although to a much lesser extent. The fall of the Rajoy government in Spain hardly caused any additional unrest because the new socialist Prime Minister Sánchez is pro-Europe and will abide by the budgetary rules. The long-term interest rate in the United States also fell below 3%, despite the economic indicators showing a stable to better momentum. Investors withdrawing capital from Europe can find shelter in the US government bonds, considered safe. The emerging markets were also affected by capital outflows. In the general trend of risk aversion, corporate bonds fell back.
Central banks and monetary policy
It was a quiet month for central banks. The European Central Bank largely refrained from commenting on the political situation in Italy, but nevertheless expressed concern about the inevitable increase in the budget deficit if the government programme is implemented. Economists debated whether this would have an impact on the timing of the ECB’s phasing out the bond purchase programme, now anticipated to start as from September. The report of the last FOMC meeting shows that the Federal Reserve has confidence in the economic outlook and that inflation will reach the 2% level. It confirmed the market’s view that the second rise in interest rates in 2018 will take place in June. There were no additional indications in the report about whether one or even two additional rises will follow this year. The market also remains divided about this outlook. On June 10, a referendum will be held in Switzerland concerning the possibility for banks to continue to provide credit to businesses and families without there being an equal amount of reserves with the central bank. According to the supporters, the aim is to make the financial system safer and it is another consequence of the financial crisis of 2008. Opponents, including the Swiss Central Bank, are fearful of the impact on the economy. Opinion polls indicate that the proposal will not secure a majority.
Foreign currencies also showed a strong interest in “safe” investments in May. The euro lost ground against the most other major currencies. The dollar rose by 3.6%, almost reaching a level of 1.15 against the euro at the height of the uncertainty surrounding Italy. The stronger momentum that can be observed in the recent economic figures of the United States when compared to the eurozone and the associated interest rate advantage enjoyed by American bonds also play a role. Other safe currencies also performed strongly, with the JPY rising by 3.9% and the CHF rising by 4.0% against the euro, albeit after a number of previous weak months on the part of the latter. The Norwegian krone strengthened (+1.5% against the euro) following the central bank’s confirmation that an interest rate rise after the summer continues to be an option and because of the rise in oil prices.
As expected, the US left the nuclear deal that was concluded with Iran in 2015 together with Russia, China, France, Germany and the United Kingdom. Specifically, the embargo on Iran’s oil exports will be reintroduced within six months. As a result, the oil price initially rose further to USD 80/barrel. The surprise was then great when Saudi Arabia announced its intention to reduce the production restrictions in force since the beginning of 2017 in order to compensate for the reduced supply from Iran and the loss of production in Venezuela. This possibly occurred under pressure from the United States. This plan will be given substance at a meeting between OPEC and Russia on June 22 and 23. This news resulted in the oil price falling somewhat again. Industrial metals remain positively oriented due to a sustained demand. Despite the uncertain market situation in May, the price of gold hardly changed, because of the rise in the dollar.
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