Market Insights – 10th of June 2019

Each week, a team of experts shares its market views with you.

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Essentials

The European Central Bank made a less accommodative move than expected when it pushed its first rate hike back from late 2019 to June 2020. The euro rose and stock markets lost ground on the news. Judging by this preliminar reaction, investors had thought that the ECB would bring in a larger raft of stimulus measures to get through the economic soft patch.

In the USA, weak job creation figures, which came in at 75,000 instead of the forecast 175,000, are not in themselves cause for concern, as they tend to be volatile from one month to the next. One positive sign, however, is wage growth, which remained moderate and should not push up inflation. That will strengthen the Fed’s argument as it adopts a more dovish tone.

Long-term interest rates dropped to a record low in Germany as manufacturing output slowed considerably. The annual yield on ten-year bonds now stands at –0.25%. This trend is spreading to the rest of Europe, including to lower-rated countries like Italy, where ten-year yields have fallen to 2.35%.

Did the late-May volatility change Powell’s (and Trump’s) mind?

Risks for the US economy have certainly increased in recent weeks. After the economy picked up in 2017, the Fed tightened its monetary policy in 2018 in order to ensure a soft landing at a time of full employment. But the final approach is now being swept of course by the trade turbulence between the USA and its main trading partners, including China and Mexico. It’s got to the point where the Fed is seriously considering revving the engines and putting off the landing until things are clearer on the trade horizon.

Recent comments from Fed official suggest as much. Fed chair Jerome Powell in particular is clearly laying the groundwork for rate cuts in the second half of the year, suggesting that the Fed is reacting to Wall Street’s recent slide. So is a Powell put in place? And as for Donald Trump, he’s been more moderate in recent days, both during his European tour and on social media. Could there perhaps be a Trump put too? It’s clear that US government officials are still swayed by the financial markets.

Ten years after the financial crisis, there is little tolerance for falling markets in a deeply disinflationary climate. Mr Powell seems to be reacting more to the sharp drop in long-term Treasury yields than to recent stock-market volatility. The ten-year yield has fallen to nearly 2%, down from 3.25% last autumn. What’s more, the yield curve is starting to invert, which means that short-term rates are now higher than long-term rates. This unusual phenomenon is often a sign that the Fed is not keeping up with economic developments. It’s therefore time for it to change course, meaning that low interest rates are by no means a thing of the past.

This climate remains good for equities, and dividend yields are now higher than bond yields in most developed countries. We’ll nevertheless be keeping an eye on Mr Trump’s outbursts, especially in the run-up to the G20 summit in Osaka in late June. The market rally that began last week might not continue unless trade tensions ease a bit.

A storm in the Pacific

Market expectations have quickly done an about-turn. An easing of tensions between the USA and China now seems to be the least likely scenario, with most analysts instead expecting the deal to be put off and tariffs to be brought in on the remaining USD 300 billion in Chinese goods. Negotiations concerning the list of imports will end on 24 June, and after that date the White House could announce a decision at any moment.

But it’s futile to follow the rumours – or the tweets – too closely, or to try and predict how the negotiations will pan out. As we’ve seen with Mexico, threats can come and go in the space of a week. This looks to be the new status quo, so business leaders will have to learn to navigate this sea of uncertainty and get used to a trading system that is no longer based so much on trust. But even though the talks have stalled and a 25% tariff could be brought in if President Xi fails to show up at the G20 summit, additional non-tariff-related measures, like the embargo on Huawei, seem less likely in the short term, as they could harm the USA as well as China.

Against this backdrop, investors will have to wait for confirmation that the two presidents will indeed meet on 29 June, and then they’ll have to wait and see what tone the two leaders adopt coming out of that meeting. Only then will they be able to work out whether the storm will strengthen or peter out in the third quarter.

To go deeper

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