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Market Insights – June, 18th 2018

Weekly financial & economic analysis.

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Essentials

Germany’s right wing is embroiled in infighting over immigration. That’s not good news for Angela Merkel, who is starting her fourth term in a much weaker position. According to recent opinion polls, support for her coalition has already dropped 4% since tensions began.

In the run up to the next Opec meeting, oil prices have tumbled more than 10% from the recent high. That’s largely due to the standoff between Saudi Arabia and Russia who want to ramp up production, and Iran and Venezuela, who want to keep oil prices high.

Recent economic data from China fell short of expectations. Industrial production grew only by 6.8% yoy in May, while the growth in retail sales was 8.5% and 6.1% for FAI for the first five months of the year. This blip is primarily due to the measures in credit supply control imposed by the Chinese government in recent months.

Mario pulls the plug on the QE party

The long period of unconventional monetary policy will soon be coming to an end. Last week, the European Central Bank announced that its asset purchase programme will be wound up at the end of the year. Starting in January 2019, money will stop being injected into the eurozone economy once and for all – only the Bank of Japan will carry on its quantitative easing for a so far undetermined period. Europe’s bond market reacted quite well to the ECB’s announcement; long-term yields even dropped slightly on the news. Draghi seems to want to keep investors happy for a little while longer, as he was quick to state that he does not intend to raise interest rates any time soon. Forex markets, however, reacted more harshly, with the US dollar rising sharply – especially against the euro.

While the ECB is biding its time, the Federal Reserve is still raising interest rates, with a further 0.25% hike last week. Although the greenback seems somewhat overbought in the short term, forex traders would like to see other central banks follow the Fed’s footsteps and seem to prefer the currencies that are exposed to further rate hikes. If you look at US bond markets, the Fed’s monetary policy tightening has not really had an impact on long-term yields, which is quite surprising. Ten-year T-bond yields didn’t move following Mr Powell’s latest announcement. The yield curve is flattening, and this is all the more visible on ultra-long maturities: 30-year yields dropped sharply, almost reaching the 3% mark, where ten-year yields have been hovering for several weeks. It’s still likely too early to say that this flattening is a sign that the US economy will start to slow. For the time being, the country’s economic momentum is still far outstripping expectations.

The US stock market needs to catch its breath

The US macroeconomic indicators released last week were still quite bullish. The small and mid-cap sentiment index, for instance, reached levels not seen since 1983. It’s therefore not surprising that the Russell 2000 rose for the seventh week in a row, reaching a record high. Tech stocks didn’t get left behind either, with the Nasdaq also climbing to new summits. This confirms that investors continue to be bullish on small-cap high-growth companies, which have played a major role in the stock-market uptrend so far this year.

However, these two indexes seem to be largely overbought from a technical standpoint, and we expect the market to take a breather in the near-term. We don’t think the S&P 500 will get back to its end-January level in the coming days. Investors would be wise to consider sectors that have lagged since the start of the year. Consumer staples, for instance, have fallen 10% since January, and are now attracting investors’ attention. This sector is one of the very few that are no longer trading at a premium over the S&P 500 – a sign that defensive stocks have fallen out of favour. A move back into these higher-quality stocks therefore seems justified at this point.

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