Market Insights – April 30th

Weekly financial & economic analysis.

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A sense of optimism has been in the air since the meeting between the leaders of North and South Korea. The previously glacial relations between the two countries seem to be thawing. The big question now is whether their words can be turned into deeds. The road to peace will no doubt be long and bumpy, which is why Asian markets posted only timid gains last week.

Mr Draghi offered reassuring comments on the economy and inflation at last week’s European Central Bank meeting. Unsurprisingly, the financial markets’ response was muted, with yields dropping slightly and the US dollar continuing to rise against the euro.

Japanese inflation is still desperately short of the target set by the Bank of Japan (BoJ). The Tokyo Consumer Price Index has put in a disappointing performance for several months now, with the rise in prices dropping from 1.4% at the start of the year to 0.5% more recently. With these figures, the BoJ is unlikely to make any changes to its monetary policy.

All eyes are still on US yields

The geopolitical risks that have held investors’ attention in recent weeks are starting to fade. Tensions have eased both on the Korean peninsula and in the Middle East, as has talk of a trade war between the USA and China. Investors are instead starting to worry about inflation again, especially in the USA, which is reaching full employment after close to ten years of uninterrupted economic growth. Economists are afraid that if inflation outpaces expectations, the Federal Reserve will have no choice but to speed up its monetary policy tightening, which could bring an end to one of the longest macro
cycles in modern history. Yet indicators still suggest that inflation is increasing very gradually in the USA and is unlikely to spin out of control. This was confirmed by the much-awaited Q1 figures released last week. The Fed keeps a close eye on the deflators used by the US Commerce Department, particularly the Personal Consumption Expenditures (PCE) deflator. While the Q1 figure came in close to the 2% target set by the Fed, the feared surge has not materialised. These data have helped to calm the US bond market. Ten-year yields fell after briefly crossing the psychological threshold of 3%. Most other bond markets around the world
then followed suit, led by those in Europe, where initial April inflation estimates confirmed the absence of any real uptick in inflation. The assets and currencies of the main emerging markets, which have underperformed recently, also settled down. We still don’t think US long-term interest rates will rise much above 3% given the current inflation environment. But risk assets should be able to absorb a further rebound in US interest rates as long as it is slow and gradual

USA: fundamentals still strong

Only half of S&P 500 companies have so far released their earnings figures, but Q1 2018 is already shaping up to be a very good quarter. For starters, earnings growth picked up considerably during the first three months of the year. Analysts expect earnings to rise by more than 22% year on year, despite the tough basis for comparison – at 14%, growth was already strong in Q1 2017. Secondly, 80% of
companies that have so far released their results managed to beat analysts’ already ambitious forecasts.

The recent US tax reform is largely to thank for this improvement. But it is by no means the only factor – these results can also be put down to the buoyant global economic climate. Corporate top-line growth came in at 7.5%, driven by the tech sector (+14%) and very cyclical sectors like energy, materials and indus-

At the same time, many economic indicators have reassured investors – the US economy’s fundamentals are still strong. However, the market reacted coolly to these results, which could well mark a high point for US earnings growth  before things gradually return to normal. That is, unless US companies once again defy economists’ expectations.


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