Global growth maintains its momentum, supporting equity markets
In her semiannual testimony to the Congress on Wednesday, Ms Yellen expressed doubts regarding the temporary nature of the recent weakness in inflation.
However, Yellen also stressed that because the neutral rate (r*) -- an inflation-adjusted variable -- is currently low (0.06% according to Laubach-Williams estimates), the federal funds rate will not need to rise much further to achieve a neutral policy stance (see graph).
As a result, US Treasuries recovered some of their recent losses, with 10-Year yields down by 5 bps wow to 2.33%. Nevertheless, we expect the Fed to remain on track to increase its policy rate to 1.5% at some point this year, and to announce the commencement of its balance sheet normalization process in either September or December.
The ECB is expected to remain on hold on Thursday (interest rates, asset purchases of €60bn per month at least until December 2017), laying the ground for the September meeting, at which new ECB forecasts for GDP and inflation will be published and an announcement regarding the evolution of the QE programme will likely be made.
Global equity markets recorded strong gains (MSCI World: +1.8% wow in $ terms, +11.2% YtD), as risk appetite improved due to dovish remarks by Yellen and strong economic data (ex-US). The euro area (+1.9%) and emerging markets overperformed (+4.4% in $ terms) on a weekly basis.
The encouraging outcome for China’s Q2 GDP adds to the positive global growth outlook. GDP increased by 6.9% yoy in Q2:17 (consensus: 6.8%), unchanged from Q1:17 and from 6.8% in H2:16, mainly on the back of increased (and possibly front-loaded) infrastructure spending, as well as strong trade activity.
Investors are now focusing on the earnings season. With equity multiple valuations (ex-Japan) a good bit above historical averages (12-month forward P/E of S&P500: 17.7 vs 15.6 avg, Eurostoxx: 15.2 vs 13.6 avg), earnings growth needs to be the catalyst for further capital gains.
The US earnings reporting season for Q2:2017 started on a positive note. Of the 30 S&P500 companies that have reported so far, 80% have exceeded analyst EPS estimates. The majority of S&P500 earnings announcements (80% of market cap) is concentrated on the period July 21 - August 4.
Announcements of US Financials’ earnings started on Friday, with Citigroup ($1.28) and JPM ($1.82) posting EPS above consensus estimates, despite annual declines on trading revenues. Higher interest rates, lighter regulation and the successful completion of the 2017 CCAR “stress tests” results are likely to provide further support to Financials (+6.8% YtD).
Consensus expects S&P500 EPS growth to slow from 14% yoy in Q1 to 6.6% yoy in Q2 and 9.6% yoy (on average) in H2:2017. Stronger US GDP growth (above 2%) and fading FX strength (-1.4% yoy in NEER terms in H2:2017, assuming the USD remains at current levels) may push earnings higher in the second half. In contrast, declining profit margins (10.6% in Q1:2017) due to a tighter labor market (higher wages) is likely to provide a constraint to S&P500 EPS profitability.