Friday 07/12/2018

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Investment Desk Analyst

The resurgence of the trade dispute, central banks, Italy, OPEC, etc. - numerous events affected the market in June. Our expert, Johan Gallopyn, outlines the implications for the equity, bond and currency markets over the past month.

Equity markets

Threats and tweets were thrown back and forth between the United States and China and Europe. Concrete measures remain limited for the time being, but could start to take effect in early July. The impact for the trading partners could be more significant than for the US itself. The European economy is very open and, like the Chinese economy, is already moving towards a slower growth rate. If the import duties that are currently on the table (active and threatened), totalling USD 450 billion, were actually implemented, then that would affect the larger part of China’s exports to the US. To mitigate the impact on the economy, China’s central bank has already lowered the reserve ratio that commercial banks must hold with it, making it easier for them to lend. In Germany, the automotive sector lay under fire and Daimler was the first major company to issue a profit warning as a result of the expectation of lower sales and higher costs resulting from the trade tariffs. The share prices of other German carmakers also suffered a fall. In this market environment, the US equity market outperformed the European one and was the only region to show a positive performance over the past month (MSCI US +0.6% in euro). As a matter of fact, the Nasdaq Composite index was even able to reach a new all-time high. Once again, the emerging markets performed less well. Company results for the second quarter will be published in the coming weeks, and expectations for the S&P 500 companies are high, with an earnings increase of 20.0% (analyst consensus) compared to the second quarter of last year. 

 

 

Bond markets

After an Italian Government was finally formed with a coalition of Lega and the Five Star Movement, there was some relaxation in the European bond market. The government reiterated its intention to implement a tax cut and a minimum income - with consequences for the budget - but also confirmed that it does not question Italy’s membership in the euro. The yield on ‘safe’ 10-year German bonds  subsequently backed up to 0.50%, while the yield on Italian bonds fell. Nevertheless, it remains one full percentage point higher (around 2.75%) than before the government formation crisis. For the other periphery countries, rates have largely normalised. After the ECB meeting signalling a cautious approach and the resumption of trade frictions, the German rate fell again to close the month at around 0.30%. The American 10-year yield fluctuated in a fairly narrow spread between 2.8% and 3.0%, within which it has found itself for a number of months. The differential between the 10-year and 2-year yield declined further to 30 basis points, the lowest level since 2007. The yield on short-term bonds was driven higher by the expected interest rate policy of the Federal Reserve, while longer term bonds were squeezed by investors seeking a safe investment. Corporate bond spreads were again slightly higher in a general move towards risk-averse investments.

 

 

Central banks and monetary policy

The meetings of the central banks in the US and in the euro zone provided a better insight into future monetary policy. As generally expected, the Federal Reserve implemented this year’s second 25 basis points rise in the short-term rate and painted a positive picture of the economic situation. More important was the shift in expectations, as most of the Fed members now expect a total of four rate hikes in 2018 instead of three. This is a scenario that the market had already been taking into account, but its confirmation, together with the accompanying comments, was nevertheless seen as a less flexible position than previously. The European Central Bank announced that it will halve its bond purchase programme as from October to EUR 15 billion per month until December, after which it will end. With regard to the timing of a first interest rate rise, the ECB’s outlook remains very cautious. An increase is now expected after the summer of 2019, somewhat later than what the market had been anticipating up to now. The Norwegian Central Bank made it very clear that it will most likely raise its rate in September. In turn, the Bank of England may already take that step in August.

 

 

Currencies

Despite the resurgence of trade tensions, political uncertainty in the euro zone and the ECB’s accommodative stance, the euro strengthened against most other currencies last month. Against the dollar the euro remained virtually unchanged over the past month, but over the second quarter the US currency rose by a substantial 5.3%. The British pound fell slightly in June, despite the Bank of England’s hawkish position. Brexit negotiations continue to be very difficult. The commodity related currencies also fell as a result of weaker commodities prices. The Norwegian krone strengthened, however, after the central bank confirmed that a rate rise is probable in September. China’s yuan lost considerable ground, primarily against the USD, with the Chinese currency reaching its lowest level since the beginning of the year. Trade tensions with the US and signals of slower economic growth weighed on sentiment. It is expected that the Chinese central bank could start to ease monetary policy, but there is also a possibility that China will use the depreciation of its currency as a weapon in the trade dispute.

 

 

Commodities

OPEC and Russia just about undid the production restrictions introduced in early 2017 by announcing production of an additional 1 million barrels per day as from the beginning of July. Nevertheless, the price of oil rose to just under USD 80 per barrel, even though the announcement was generally expected. In practice, the additional production should only amount to 600,000 barrels since most producers - with the exception of Saudi Arabia - have very little spare capacity available (3 million barrels a day of which 2 million barrels in Saudi Arabia, according to the IEA). The fact that OPEC and other producers are still able to come up with a common position is also supporting oil prices. The United States has been putting pressure on Saudi Arabia to use its spare capacity to compensate for Iran’s loss of production as a result of the renewed embargo. Industrial metals had a weak month (GSCI Industrials -5.1%). This was due to a number of factors: signals of slower growth in China (the largest user of metals), a strong dollar and the escalating trade conflict that could lead to slower global growth. The price of gold briefly touched the level of USD 1,300 per ounce in June, but suffered a sharp fall in the second half of the month following the FED’s upward revision of interest rate expectation.

 

 

 

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