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Market Insights – April 9th, 2018

Weekly financial & economic analysis.

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Essentials

The latest economic newsflow from Germany has been disappointing, especially industrial output and new orders. Although these indicators are still very high, they suggest that the economy is going through a weak spot. This should be temporary, however, given the strength of global growth.

The British pound looks set to break out of the trading range it has been in since last September and test new recent highs. This uptrend may be triggered by the brighter economic outlook. The country’s property market has stabilised and even risen slightly, which is also reassuring.

Spreads on European financials widened during the recent bond market correction. Yields on subordinate bank debt that will no longer be eligible under the upcoming Basel 3 reform hit 4.6%, which makes them attractive in our opinion.

Europe’s bond market is full of surprises!

After several calm months – if not years – the first few weeks of 2018 served as a reminder that fixed-income investments still present some risk. Volatility and daily price fluctuations on most bond markets have been much higher than we have grown accustomed to recently. This new configuration has been caused by fears of a surge in wage-driven inflation in the USA. It’s normal for salaries to go up when an economy is nearing full employment and at this late stage in the macro cycle. For the moment, wages are still increasing quite slowly and are probably being held back by major structural changes in the economy, such as the rise of online shopping and digitisation. US inflation has not yet taken off and is edging closer to the Fed’s 2% target; the Fed can therefore continue to very gradually tighten monetary policy. In Europe, inflation is still much lower, hovering around 1% year over year. Market turbulence at the start of the year pushed US ten-year yields towards the psychological threshold of 3%. But they have dropped off again in recent weeks, with long-term yields falling to 2.75%. Bond yields have followed an even more surprising trend in Europe, where interest rates are still close to zero in many countries despite the real improvement in the economic climate. Swiss ten-year yields, which picked up sharply at the start of the year, are once again nearing negative territory. This is unexpected given that all economic signals are on green for the Swiss economy and unemployment is at its lowest since 2012 (2.9%) and gradually reaching a structural level that it would be hard for it to fall below. So we’re still waiting for European bond yields to return to normal. It’s just a matter of time, however, and will largely depend on when the European Central Bank (ECB) winds up its quantitative easing. We expect this to happen near the end of this year. The ECB will then stop buying bonds, which should in all logic push yields higher.  

Volatility likely to drop

Last week, investors’ attention was well and truly focused on the threats that President Trump was directing at the USA’s trading partners, especially China. With fears of a trade war between the two superpowers, volatility remained high on the stock market. It is well above levels recorded last year, a sign of just how worried investors are. We think that it is unlikely the customs tariffs will actually come into effect and that talks between Washington and Beijing will probably lead to some kind of compromise. What’s more, US economic fundamentals are still solid, as demonstrated by the jobs figures published on Friday. Even if last month’s data were disappointing – with 103,000 new jobs created (versus the 185,000 forecast) – the three-month average is still 200,000, which is particularly noteworthy given that the USA is close to full employment. It is also reassuring that hourly wage growth remains under control at 2.7%, as it means we can rule out a possible surge in inflation in the short term. The earnings season looks set to be a good one, so market operators should be able to turn their attention back to the buoyant climate for companies, which might then bring down volatility and trigger a stock-market rebound. 

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