Εβδομαδιαία Επισκόπηση: Διεθνής Οικονομία & Αγορές, 21/02/23
US equities are flat month-to-date (+6% in January), as investors price in more interest rate hikes by the Federal Reserve
Key Takeaways
The latest set of macro data has led investors to revise up further their expectations for the federal funds terminal rate at a range of 5.25% - 5.5% (from 4.75% - 5% in late January). According to the Fed, ongoing increases in the target rate will be appropriate, with (hawkish) FOMC members emphasizing the likelihood of increasing rates for longer than previously anticipated.
In a similar vein, market pricing for ECB policy rates moved up by circa +10 bps in the past week and now points to further hikes of +125 bps by mid-2023. According to the ECB, there is a strong commitment for an additional interest rate hike of 50 basis points in March 2023, and then it will evaluate the subsequent path of monetary policy (current Deposit Facility Rate: +2.5% | rate on Main Refinancing Operations: 3.0%).
The upward repricing by investors of the path of monetary policy interest rates and higher breakeven inflation rates sent core government bond yields up in the past week by circa +10 bps in the 2 to 10-year tenors in both the US and Germany (10-year: 3.83% and 2.45%, respectively). So far this month, nominal 10-Year UST yields are up by +31 bps, with real rates leading the increase (+19 bps to +1.46%, +12 bps for breakeven rates to 2.37%).
US equities, following the strongest gain in January since 2019 (+6.2%), paused for breath in February. On the other hand, euro area equities continue to advance (+2.7% in February and +12% ytd), albeit from lower valuation layers, as downside risks related to energy supply have diminished. Recall that natural gas storage levels in the European Union currently stand at levels 46% above their 2015 -2020 average for the same period (64% of storage capacity). As a result, European natural gas prices have fallen sharply, with the “spot” Dutch TTF below the 50 mark (€48/MWh) for the first time since early-September 2021.
Sectoral weights have supported euro area equities as well. EuroStoxx Banks (+22% ytd), which benefit from the higher interest rate environment, alongside a less malign macroeconomic outlook, represent c. 10% of the headline index’s market capitalization. The respective share for S&P500 Banks (+9% ytd) stands at c. 4%. Recall that index relative weights (i.e. Technology, Banks) explain a large portion of the significant overperformance of US equities in the aftermath of the Global Financial Crisis.
At the same time S&P500 valuations appear relatively stretched. In the event, the 12-month forward Price-to-Earnings ratio (P/E) stands at 18.5x (as of February 16th) versus an average of 16.4x since 1999 (at the 80th percentile in that period), whereas the respective ratio for the EuroStoxx stands at 12.7x versus an average of 13.9x since 1999 (at the 37th percentile in that period).
A more benign recent path for earnings expectations, in turn aided by the dissipation of sharply negative economic risks, has been a key factor for the relative gains of euro area equities. Indeed, 12-month forward Earnings-Per-Share estimates have fallen by -6% since a peak in July 2022 for the S&P500 to $225, whereas rising by +4% in the same period for the EuroStoxx to €36.
Key Takeaways
The latest set of macro data has led investors to revise up further their expectations for the federal funds terminal rate at a range of 5.25% - 5.5% (from 4.75% - 5% in late January). According to the Fed, ongoing increases in the target rate will be appropriate, with (hawkish) FOMC members emphasizing the likelihood of increasing rates for longer than previously anticipated.
In a similar vein, market pricing for ECB policy rates moved up by circa +10 bps in the past week and now points to further hikes of +125 bps by mid-2023. According to the ECB, there is a strong commitment for an additional interest rate hike of 50 basis points in March 2023, and then it will evaluate the subsequent path of monetary policy (current Deposit Facility Rate: +2.5% | rate on Main Refinancing Operations: 3.0%).
The upward repricing by investors of the path of monetary policy interest rates and higher breakeven inflation rates sent core government bond yields up in the past week by circa +10 bps in the 2 to 10-year tenors in both the US and Germany (10-year: 3.83% and 2.45%, respectively). So far this month, nominal 10-Year UST yields are up by +31 bps, with real rates leading the increase (+19 bps to +1.46%, +12 bps for breakeven rates to 2.37%).
US equities, following the strongest gain in January since 2019 (+6.2%), paused for breath in February. On the other hand, euro area equities continue to advance (+2.7% in February and +12% ytd), albeit from lower valuation layers, as downside risks related to energy supply have diminished. Recall that natural gas storage levels in the European Union currently stand at levels 46% above their 2015 -2020 average for the same period (64% of storage capacity). As a result, European natural gas prices have fallen sharply, with the “spot” Dutch TTF below the 50 mark (€48/MWh) for the first time since early-September 2021.
Sectoral weights have supported euro area equities as well. EuroStoxx Banks (+22% ytd), which benefit from the higher interest rate environment, alongside a less malign macroeconomic outlook, represent c. 10% of the headline index’s market capitalization. The respective share for S&P500 Banks (+9% ytd) stands at c. 4%. Recall that index relative weights (i.e. Technology, Banks) explain a large portion of the significant overperformance of US equities in the aftermath of the Global Financial Crisis.
At the same time S&P500 valuations appear relatively stretched. In the event, the 12-month forward Price-to-Earnings ratio (P/E) stands at 18.5x (as of February 16th) versus an average of 16.4x since 1999 (at the 80th percentile in that period), whereas the respective ratio for the EuroStoxx stands at 12.7x versus an average of 13.9x since 1999 (at the 37th percentile in that period).
A more benign recent path for earnings expectations, in turn aided by the dissipation of sharply negative economic risks, has been a key factor for the relative gains of euro area equities. Indeed, 12-month forward Earnings-Per-Share estimates have fallen by -6% since a peak in July 2022 for the S&P500 to $225, whereas rising by +4% in the same period for the EuroStoxx to €36.