Coffee Break 6/26/2017

Over the past weeks, central bank meetings showed that monetary policy convergence is not for tomorrow. After an usual dovish performance of ECB President Mario Draghi, Janet Yellen chose a slightly less accommodative accompanying speech. While inflation remains subdued on both sides of the Atlantic, the Fed chair chose to dismiss the most recent declines as temporary factors. The Federal Reserve is adopting a somewhat hawkish position as US financial conditions have improved considerably during the first semester thanks to a declining USD and falling yields, while stock markets hit new record highs and spreads continued to tighten. Looking forward, the market is not buying into the Fed’s narrative of four additional rate hikes over the coming 18 months and its balance sheet reduction announcement had virtually no impact on markets.

To some extent, ECB and Fed monetary policy divergence has come back and this could reinforce the USD in the short term and put US 10Y yields under pressure. We maintain our underweight on bonds and the short duration.

Furthermore, last Monday’s “Brexit” negotiations aiming to establish priorities and secure a timetable for the UK’s departure offered little insight into how the deal would ultimately pan out. But it was a “promising start” according to the UK’s “Brexit” secretary David Davis.

In the coming weeks, we will continue to monitor political developments from both sides of the Atlantic and central banks ‘meetings.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are tactically neutral on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are less uniform than at the turn of the year. The economic news flow is less supportive in the US and we lack a catalyst or a market setback to become more constructive. The European recovery is well on track and should lead to above-potential growth in 2017-18, leading us to raise profit expectations. We think that the euro zone and emerging economies are best placed to leverage on these dynamics.
• Central banks’ tone remains dovish, but policies diverge:
  • The Fed increased its funds rate for the fourth time in this cycle and gave more details on how it could start reducing its balance sheet “relatively soon”, although no specific date was provided. We believe the balance sheet reduction should start as soon as September.
  • The ECB adopted a dovish tone during its last meeting, as inflation still needs time to increase. Tapering should however become a central theme after the summer.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
• The main risks for equity markets remain political and have switched from Europe to the US:
  • Italian elections are unlikely to be held in 2017.
  • The UK elections outcome has led to more uncertainties on the tone of the “Brexit” negotiations.
  • The geopolitical tensions in Syria, North Korea and potentially Iran may cause uncertainty.
  • The slippage in the timing of the fiscal stimulus due to the lack of political success in Congress and the investigation targeting the President question the credibility of the Trump presidency.

REGIONAL EQUITY STRATEGY

• We remain positive on euro zone equities. The on-going, more robust and geographically broadening economic expansion, an accommodative central bank and a strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. Furthermore, relative valuations are attractive and non-resident flows should continue to pick up.
• We maintain an underweight on Europe ex-EMU, especially the UK. The uncertainties surrounding the UK’s political situation, the “Brexit” negotiations and the impact on the economy lead us to avoid the region.
• We keep our neutral stance on US equities. The US cyclical recovery stalled in Q1 and activity data has yet to catch up with survey optimism. Negative surprises are approaching extreme levels.
• We have re-examined the case for Japanese equities and decided to maintain our neutral stance. The Japanese economy is supported by favourable conditions, such as a supportive policy mix, solid domestic consumption and a tight labour market. In this economic environment and taking into account companies’ dependence on global growth, earnings should further improve. Valuation is also not expensive, but the technical short-term upside looks limited. Furthermore, the JPY-evolution will remain an important market driver, in particular for non-resident flows.
• We maintain an overweight on emerging market equities. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year and most recent data (foreign reserves, retail sales, industrial production, loans) are rather supportive.

BOND STRATEGY

• We maintain our underweight on bonds and a short duration. With a relatively hawkish Fed and labour market conditions in place to increase inflationary pressures, we expect rates and bond yields to resume their uptrend. The improvement in the European economy could also lead euro zone yields higher as political risks recede and the ECB should start detailing its tapering in the second half.
• We continue to diversify out of low/negative yielding government bonds:
  • We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • We have a diversification in inflation-linked bonds.
  • We have a slight overweight in emerging market debt as it benefits from strong fundamentals and an attractive carry. Contagion from Brazil to the rest of the emerging markets has been contained.
  • We are close to a neutral high yield exposure: the spread compression has exceeded our targets on both sides of the Atlantic, but the carry remains attractive.
  • On the currency side, we remain cautious on the GBP in the light of the on-going “Brexit” negotiations. 

• In the US, initial jobless claims increased slightly by 3000 to a seasonally adjusted 241,000. This was the 120th consecutive week that claims have been below 300,000, the threshold associated with a strong labour market.
• The Markit Flash Manufacturing PMI fell to a 9-month low (52.1 in June, from 52.7 in May) and below consensus estimate of 53. This decline was largely due to softer rates of output and new business growth, which more than offset stronger contributions from job creation and inventory building.
• In the euro zone, the Markit Flash composite PMI declined to a 5-month low of 55.7 from 56.8 the previous month but was still the strongest for over 6 years. The reading was dragged down by a retreat in the services sector.
• In Germany, both Markit Flash manufacturing and services PMI fell respectively to 59.3 and 53.7 in June.
• Meanwhile, new orders grew at the fastest pace since March 2011 supported by strong demand from Europe, America and Asia. 

EUROPE

Slightly negative week for European equities.

• The sharp decline in the price of oil dominated stock market mood last week.
• Energy shares dragged markets lower.
• Basic materials, banks, consumer goods and health care sectors also suffered from the mixed signals sent by the release of the most recent data over the euro zone economy.

US

Slightly positive week for US equities.

• US markets ended the week mixed as energy shares weighed on the major indexes for much of the week due to the falling oil price.
• But financials and technology stocks fared well during the week.
• Homebuilders also fared well on news of better-than-expected gains in sales of new and existing homes.
• The health care sector moved higher after the publication by the Senate Republicans of their version of the new bill to replace the Affordable Care Act.

EMERGING MARKETS

Weekly gain for Emerging market stocks.

• Chinese mainland share were in buoyant mood after index provider MSCI said it would allow some of them into the emerging markets benchmark from 2018. China Shenzhen-listed stocks gained almost 3% on the news.
• South Africa rebounded after parliament said it would launch a court challenge against an anti-graft watchdog’s recommendation of constitutional changes to alter the central banks’ mandate.
• Russia, on the other hand, was down for the week, after touching its lowest level since November 2016.
• Brazil also had a difficult week as concerns that a mounting political crisis could delay the implementation of structural reforms. 

RATES

German rates traded in a tight range last week.

• 10Y German yield continued to trade in a tight range over the week while semi core countries eased slightly (namely France, Belgium) in the wake of the drop in crude oil.
• 10Y euro zone breakeven inflation declined to 0.96% and peripheral spreads benefitted from the risk on mode as Fitch raised its outlook on Portugal and S&P upgraded Slovenia.
• The 10Y Italy/Germany spread declined to 165bp and 10Y Spain/Germany to 112bp.
• 10Y US, UK, Japan and German yields stood at respectively 2.15%, 1.04%, 0.04% and 0.25%. 

CREDIT

The cash market continued its tightening trend last week.

• The cash market lost 2bp during the week (105bp for EUR Investment Grade credit) despite the plunge in oil price (a 10-month low), which put some pressure on US High Yield.
• The credit market has been marked by the strong performance of Financials CDS. The move, which is largely technical comes after Markit released a change to the iTraxx Europe Series 28 composition:
• Despite the sharp tightening in synthetic indices, Financials cash bonds were little changed.
• The primary market was close to EUR 15bn, which was the busiest week since mid-May.
• Some issuers may be front-loading their supply ahead of a potential ECB tapering later this year. 

FOREX

Stability of EUR and USD versus EM and commodity currencies.

• The sharp drop in oil lead to a massive underperformance of EM (BRL, MXN) and commodity-related currencies (AUD, CAD).
• The EUR and the USD held relatively well against other most major currencies, leaving the EUR/USD cross unchanged on the week. 

WEEKLY MARKET OVERVIEW




UPCOMING FACTS AND FIGURES