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Market Insights – February 4th, 2019

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

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Essentials

British MPs have approved an amendment that rules out a no-deal Brexit, which makes a hard Brexit look less likely. But they also called for the deal to be revised. The market was probably expecting more clarifications, which led to some profit-taking on the pound.

Economic newsflow in the eurozone continues to fall short of expectations. GDP, for instance, was up just 0.2% on the previous quarter. While Italy has officially slipped into a technical recession, Germany just managed to avoid it. Markets have picked up nicely since the start of the year, which suggests that all this had already been priced in.

Oil prices continue to rise. Brent has reached USD 63 per barrel on the back of economic stimulus in China and the political upheaval in Venezuela. It has now recovered a third of the losses recorded in the final quarter of 2018.

Yields fall once again

The European Central Bank was no doubt too quick to embrace last summer’s slightly above-target rate of inflation, which further supported the decision to end its asset purchase programme and balance sheet expansion. Since then, the slump in oil prices has begun to hit inflation figures hard. They’re now heading back downwards in the eurozone, with annual inflation coming in at just 1.4%. Economic indicators have also worsened as a result of the trade tensions and the global slowdown. Given this climate, it’s hard to imagine that ECB monetary policy will continue to return to normal. In 2018, Mario Draghi hinted that the first rate hike was unlikely to happen before summer 2019. Now the chances are we won’t see a rate rise until at least 2020. Central bankers’ minds are currently elsewhere: the Fed has implied that it is taking a break in its tightening; China’s central bank is implementing aggressive stimulus measures in conjunction with the government; and the Bank of Japan keeps on quietly printing money.

The bond market has started to price in this new climate. Yields have begun to slacken – outside the USA at least. Long-term yields are at recent lows in Europe and Japan. In Switzerland, the year-end decline seemed to have been caused by the stock-market panic and flight to safety. But since then, ten-year Confederation yields have settled comfortably in negative territory, which raises concerns about a more long-lasting trend. This widespread decline is probably a result of weak inflation rather than a sharper slowdown in economic activity. At the same time, risk premiums have become more compressed on riskier segments of the bond market. Corporate bonds have outperformed considerably since the start of the year, both at the investment-grade and high-yield ends of the market, and investors are once again turning to emerging-market debt.

USA: a recession looks further off

The last quarter of 2018 was one of the worst the US market has seen since the 2008 financial crisis, as panic-stricken investors capitulated just a few days before the year-end holidays.

We think that the catastrophic performance in late 2018 can be blamed on the loss of visibility on the financial markets. The trade war between the USA and China, the US government shutdown and the Fed’s muddled message in Q4 all caused investors to run for cover as the global economy lost momentum.

US output did indeed drop off from the unsustainably high level recorded in early 2018, but this return to normal had been largely expected, as had analysts’ subsequent downward earnings revisions. What’s more, macroeconomic indicators remain robust, and the figures published last week attest to the strength of the US economy, with the ISM manufacturing and new home sales both sharply on the rise in January. We can therefore rule out a recession in the USA over the next 12 months.

Although some uncertainty remains, we expect the country’s problems to be gradually resolved, which should help to buoy the stock market in 2019 – and we increased our exposure accordingly in January.

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