US equities reach new highs, with markets remaining complacent about Fed hikes
In her semiannual testimony to Congress, Fed Chair Yellen was positive regarding the outlook for the US economy (although slightly cautious regarding the housing market), as both employment and the inflation mandate are close to being met. The Fed will consider further gradual rate increases at its upcoming meetings.
A strong inflation report for January and positive economic data support the Fed’s view. However, the probability of a rate hike in March remains low (32%), with markets assigning a 55% likelihood for the May meeting, when there will be more clarity on US fiscal policy.
The minutes of the January 18-19 ECB meeting revealed that the Governing Council would lean towards “limited and temporary” deviations from the capital key regarding the distribution of its government bond purchases in order to facilitate the execution of the programme.
The 33% issuer limit (ECB holdings as % of an issuer’s marketable government debt) remains a binding constraint and could limit Portuguese and Irish Government bond purchases in the future, as the ECB already holds 29% and 25% of their outstanding bonds, respectively.
In Italy, ex-PM and PD leader, Renzi, called for a party leadership contest that will take place in June. Consequently, the probability of early Italian parliamentary elections has dissipated. Also, there is an increased likelihood of a break up in the PD’s left-wing. Italian 10-Year BTP yields declined by 8 bps to 2.19% during the past week.
Global equity markets remained buoyant in the past week (MSCI World: +1.1% / +20.7% yoy), amid strong earnings announcements in major regions. The S&P 500 rose 1.5% wow, to record highs, with financials the main contributor (+3.0% wow / +43.6% yoy).
The outlook for corporate earnings remains strong across the board, with consensus expecting annual growth of EPS in 2017 of 10.1% for the S&P 500 (13.2% for the EuroStoxx and at 13.5% for EM equities). However, earnings estimates have changed only slightly from November, suggesting that analysts have not incorporated tax cuts and deregulation in their projections.
EM equities continue to benefit from strong growth, attractive valuations (see graph) and small probability placed on a materialization of a protectionist US trade agenda. EM equities have overperformed their DM peers ytd (+6.3% vs +4.1%). However, that trend could change in the case of escalating trade tensions, a faster-than-currently-expected Fed tightening, and a stronger USD.
Government bond yields in major economies were little changed on a weekly basis, as the increase due to the hawkish Fed commentary and positive inflation data faded by the end of the week. Overall, 10-year USTs were broadly flat at 2.42% (albeit increasing to 2.49% mid-week), while 10-year Bunds and Gilts fell by 2-4 bps.