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Market Insights – July 9th

Weekly financial & economic analysis.

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Essentials

The US indicators released last week all suggest that economic growth is picking up, but stocks in defensive sectors – such as health care, consumer spending and public services – are the ones riding high. Could this be a sign that investors are getting early summer jitters?

The trade war between the world’s two economic superpowers has officially begun. On 6 July, the Trump administration started things off by imposing tariffs on USD 34 billion worth of Chinese goods. Unsurprisingly, Beijing immediately retaliated by placing its own tariffs on US products. Stock markets were unfazed by the news – it seems that they had already largely priced in the fallout from this initial offensive.

The Chinese services sector has gained ground. The services PMI came in at 53.9 in June, up from 52.9 in May. The country’s currency reserves also expanded, reaching USD 3.112 trillion at end-June and surpassing market expectations. Key upcoming economic announcements include the new inflation figures on 10 July and Q2 GDP growth on 16 July.

US Treasuries look good!

In June, the US economy continued to create new jobs (213,000 in total), but hourly wages increased at a steady 2.7% year on year. In previous business cycles, salaries began to rise much earlier and at a much faster pace. This time around, they are expanding very gradually, although this trend will inevitably become more widespread. As the economy nears full employment, companies are finding it more difficult to fill vacant positions, especially when they’re looking for highly skilled workers. Faster wage growth will then spread to the rest of the economy and could create inflationary pressure down the line. However, this trend will probably be very short-lived, as inflation should be kept in check by the increasing digitisation and robotisation of the US economy. And unless trade relations deteriorate considerably worldwide, we don’t think the higher customs tariffs will trigger an inflationary spiral. In fact, we think that inflationary fears may well have peaked. For one thing, commodity prices are starting to level off after surging over the past 12 months. US long-term yields are currently at 3%. This is close to their peak for this cycle, which makes them attractive. As the cycle gradually enters its later stages, investors could brace themselves for the upturn in inflation to come to an end and monetary policy to loosen. US Treasury yields are even more appealing when compared with the low returns offered by the best European sovereigns. And given that the credit cycle is also nearing an end, now is the time to start improving the quality of bond portfolios. We recommend buying US government bonds and taking profits on US high yields. But emerging-market debt is certainly the most attractive segment of the global bond market, regardless of whether they are denominated in hard or local currencies. Diversifying into this segment makes even more sense given the losses recorded last quarter.

Sentiment on the euro improves

The US dollar is still popular even after reaching new highs recently. Sentiment indicators show that investors remain very bullish on the greenback. It has gained ground against the euro, thanks in part to the Fed’s statements about inflation and the possibility of further rate hikes, together with Mario Draghi’s comments about changes to the ECB’s monetary policy. It seems that the market has already factored in this good news and more to come. But this kind of consensus will make the dollar more vulnerable if it falls short of investors’ expectations, which are still running very high. We therefore recommend erring on the side of caution when it comes to the dollar, and we still think the euro will bounce back. The single currency, which is extremely unpopular at present, should catch up once Europe’s economy stops disappointing and economic growth starts to pick up once again.

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