Market Insights – January 27th, 2020

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

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Essentials

The coronavirus death toll is increasing rapidly, and it’s still hard to tell how the repercussions will compare to those of the SARS outbreak in 2003. While there will be a number of indirect impacts caused by the fear of contamination, discretionary consumer goods will remain the most directly affected sector, especially transport, hotel and tourism companies.

Brexit- and trade-related uncertainties have subsided, prompting a better-than-expected rebound in the eurozone’s PMI, underpinned by Germany. Data from recent months suggest that output bottomed out in September.

The financial markets – and especially the bond market – reacted well to the outcome of the election in Italy’s Emilia-Romagna region. The victory for the Democratic Party should reduce the risk of political fragmentation in the short term. Mr Salvini and his Northern League had been hoping to use this election to force the current government to resign and bring about national elections.

A global recovery will weigh on the dollar

There’s no doubt that the US dollar reaped the benefits of a favourable yield spread over the past two years. Large amounts of cash flowed into US capital markets during this period of geopolitical uncertainty and lacklustre global growth. As they sought out positive yields in an ocean of negative rates, investors were prepared to turn a blind eye to the USA’s swelling twin deficits (i.e. both the fiscal and current account deficits). But things have changed, and the dollar has lost some of its appeal. The Federal Reserve’s radical change of course and its rate cuts have shrunk the USA’s yield advantage. On top of that, China and the USA have come to a truce in their trade dispute. Now that tensions have eased, both international trade and industrial output should pick up again, which will be particularly good for emerging markets. This climate is likely to weigh on the dollar, especially against the currencies that are most sensitive to global growth. These include emerging currencies, which look set to outperform in 2020. This is, of course, provided that the coronavirus epidemic now affecting China remains under control and relatively short-lived. The current outlook, however, is not so good for safe-haven currencies like the yen. This certainly suits the Japanese authorities – they’ve been doing everything they can to rein in the yen, in an attempt to wipe out the deflationary pressures that continue to hurt the Japanese economy. The SNB has its fingers crossed that the franc will follow the same course as the yen. So far it hasn’t, probably because the SNB is unwilling to move interest rates further into negative territory. The Swiss business sector is becoming increasingly critical of the SNB’s negative rate policy. And the US authorities are also keeping a close eye on the SNB and threatening to label Switzerland a currency manipulator. The SNB will therefore have no choice but to use its balance sheet sparingly in order to protect the Swiss economy.

Japan: a market ahead of its economy

For an economy that has just narrowly avoided a recession, the Topix’s rise of more than 12% since the end of August is simply impressive. It has mostly been down to external factors, and especially the easing of trade tensions. The global economy is now expected to pick up, which bodes very well for Japan’s exporters. However, domestic retail sales fell 14.2% in October after the hike in sales tax and typhoons swept across the country, before it rebounded back to 4.5% in November. In early December, Prime Minister Abe Shinzo approved a stimulus package focused on infrastructure and aimed at mitigating the negative impacts on growth. The package amounted to JPY 26 trillion and is expected to push up the country’s GDP by around 1.4%. But the implementation will be spread out over several years, with spending starting high in 2020 and then gradually declining over the following three years. Up until now, the weakness in the manufacturing sector had been mostly offset by a robust services sector. But the sales tax hike and the typhoons weighed heavily on consumer confidence and it remains to be seen whether the improvement in November can be sustained over the long term. What’s more, the Japanese stock market has quickly priced in a cyclical recovery, which means there is now little room for disappointment. Unlike in emerging markets, signs of a rebound in Japan’s economy are less tangibles. That is why we are taking a more cautious stance on this market, and therefore proactively reduced our exposure following the impressive year-end rally.

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