Market Insights – 2nd of September 2019

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

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Essentials

US consumer confidence indexes didn’t lose any ground in August despite the escalating trade war with China and the slump in manufacturing output. This is largely because the economy is close to full employment, wages are rising and financial conditions are loose.

A no-deal Brexit has become much more likely since the UK prime minister announced that he would prorogue parliament from the second week of September until 14 October to prevent MPs from properly debating his Brexit strategy. The pound held up quite well given the circumstances.

In Italy, Mr Conte was given a mandate to form a new Five Star-Democratic Party coalition government. Italian bond yields dropped as the political uncertainty faded and hopes that the European Central Bank would bring in new measures increased. This should help to boost growth.

 

When the exception becomes the norm

When the Swiss National Bank (SNB) lowered interest rates to –0.75% in January 2015, most market observers thought this dip into negative territory would be short-lived. But once it removed the EUR/CHF floor, the SNB had to really reduce the franc’s appeal to prevent it from rising, which would have hurt Swiss exports.

Looking back, the SNB appears to have achieved that goal. Although the franc did initially rise very sharply, it then stabilised at a level that the Swiss economy could handle. But the upward pressure on the franc has never disappeared completely. It resurfaces every time the global economy shows the slightest sign of weakness or when geopolitical tensions rise. If the SNB hadn’t intervened on the forex market, the franc would certainly have strengthened. It’s been more than four years since the SNB made its shock announcement, and negative interest rates look like they’ll be around for a while in Switzerland. And this unusual situation has become more widespread.

Many other countries are also having to deal with negative rates, starting with our neighbours and trading partners in the eurozone. What’s more, we’ve entered a new round of monetary stimulus. The European Central Bank has hinted that its key rate could move further into negative territory and that more quantitative easing can’t be ruled out, while other central banks have made their first move – the US Federal Reserve, for instance, has already lowered interest rates. So further rate cuts may be on the cards for the SNB as well. 

The global economy is losing steam and inflation is still at rock bottom around the world, so bond market investors seem to have come to the conclusion that negative rates are the new norm. Rates are negative on a growing number of sovereign bonds, including very long-term debt. And now it’s not only the safest issuers, like Switzerland and Germany, whose interest rates have turned negative. A number of lower-quality bonds – and even some corporates – are also affected. Negative-yielding debt has now topped a record USD 17 trillion. This situation has prompted investors to move into higher-yielding investments like equities as dividend yields are discovered once again, even if that means overlooking their higher intrinsic risk – at least in the short term.

 

Will fiscal stimulus be needed in Germany?

Germany’s status as the eurozone’s star pupil and leading economy is on shaky ground. Disappointing economic data sparked fears of a recession, which have rattled the markets in recent weeks. The German economy contracted by 0.1% in Q2, the second decline in the last four quarters. Leading business confidence indicators remain lacklustre, suggesting that the next quarter will be no better.

This is mainly because of the sharp decline in exports and in the manufacturing sector, which are usually among the main drivers of the German economy but have been hit hard by the US-China trade war and by the slump in demand from China. For the moment, domestic demand is holding up well, but there is now more of a risk that this manufacturing recession will spread to the rest of the economy.

The situation is worrying enough that the German government is thinking about introducing fiscal stimulus, even if that means the country’s books are no longer balanced. But after several years of large fiscal surpluses, Germany is no doubt the only country in the eurozone that has enough room to manoeuvre. And on top of that, the government can borrow at negative rates. If it does bring in fiscal stimulus, companies that are highly exposed to the domestic market would be the ones to go for.

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