Market Insights – April 8th 2019

Weekly financial & economic analysis.

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Essentials

After an unexplained soft spot in February, the US labour market bounced back, with 200,000 jobs added in March. Also reassuring was the lower-than-expected 3.2% rise in wages. These figures suggest that a surge in US inflation is still unlikely.

The Reserve Bank of India carried out its second rate cut of the year, to 6%, helped along by reduced inflationary pressures. The decision comes a week before the start of the general elections, which will be held in stages up to 9 May.

German factory orders unexpectedly dropped 4.2% month over month in February – a sign that the country’s manufacturing sector is not out of the woods yet. The root of the problem is international orders, which have been hit by the more lacklustre global economy, particularly in the automobile sector.  

Is Europe facing the same fate as Japan?

Germany has once again joined Switzerland and Japan as one of the very few countries that can borrow money over the long term without having to spend a thing. Despite ticking back up slightly last week, the ten-year Bund yield is at zero, while Japanese long-term yields are in slightly negative territory. They’re both still above the –0.3% yield on Swiss government ten-year bonds – an interest rate that enables Switzerland to gradually lighten its already small debt load without effort. These developments reflect the recent softness in German manufacturing output, as well as the return by central banks to very accommodative monetary policies. ECB President Mario Draghi, for instance, decided to fire one last shot before he leaves office this coming October, announcing a fresh round of zero-interest-rate loans for eurozone banks. So central banks won’t stop printing money just yet. But given the trillions in cash that have been injected into the system for almost a decade now, it’s surprising that inflation figures are still so weak. Just about everywhere, consumer-price growth is starting to decline – and in any case it is far from the 2% target set by most policy-makers. The slowdown in inflation in the eurozone gives pause for thought. In March, core inflation – which excludes volatile components such as energy and farming products – dropped to 0.8% year over year. This is close to the recent low of 0.6% recorded in March 2015. In Switzerland, core inflation is still at rock bottom, at 0.5% year on year.

As inflation remains low across much of the developed world, monetary-policy normalisation will remain on hold. That’s also true in the USA, where the Fed – which is furthest along in the tightening cycle – has announced it will not raise rates in 2019.  Politicians of all persuasions have even started calling on the Fed to buck the trend and cut its key rates in the coming months. With rates at zero or even negative, the best place to find attractive returns is in the riskier segments of the bond market, such as US corporates, emerging-market debt, and eurozone periphery bonds.

A well-deserved rebound?

In the space of just a few weeks, investor sentiment on emerging stock markets has swung from extremely bearish to broadly bullish. But is this market turnaround justified? All of the negative factors that we have mentioned in the past as weighing on emerging-market equities – a strong dollar, rising inflation, and a slowdown in China due to the country’s deleveraging – have now improved. Whether the emerging-market rally will continue will depend on two things: the effectiveness of Beijing’s stimulus measures, and the outcome of the US-China trade war. Regarding a turnaround in China’s economy, we believe that the government’s current stimulus measures will be more limited in both duration and magnitude than in prior years and will start to be phased out before the end of the year. However, the consequences of looser lending conditions are just now starting to be felt in the real economy, as capital spending is picking up and lending is stabilising. Regarding the US-China trade war, it seems the risk of an escalation has diminished for the time being. President Trump had pledged to raise tariffs on Chinese goods if no agreement was reached before the beginning of March, yet so far no deal has been struck and no additional tariffs have been brought in. For the time being, there is no need for extreme caution on stock markets in the region.

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