Geopolitical uncertainty offsets strong economic data
Markets were mostly in risk-off mode in August due to (i) geopolitical concerns, that escalated on Tuesday when North Korea fired a missile over Japan and (ii) increasing political uncertainty in the US. Global equities lost ground, core government bond yields declined and speculative grade bond spreads widened (see below).
Doubts were raised over the ability of the US administration to push forward its policy agenda following President Trump’s handling of events in Charlottesville and his renewed threat to withdraw from NAFTA, as well as the forthcoming debates on (i) the Government debt ceiling; and (ii) a new spending bill to avoid a Government shutdown (both issues must be resolved by end-September).
On a positive note, economic fundamentals remain strong, companies earnings’ growth was robust in Q2 (S&P 500 EPS: 10% yoy, Stoxx600 EPS: 15% yoy) and central banks appear to be in no hurry to tighten policy as inflation risks remain low. Note that US core CPI undershot consensus expectations for the past five months, hovering at 1.7% yoy, from a peak of 2.3% yoy in January 2017.
The Atlanta Fed’s GDP Nowcast model points to US GDP growth of 3.4% qoq saar (2.2% yoy) in Q3, due to strong consumption and a strong labor market. At the same time, in Japan, GDP growth surprised on the upside, reaching a strong 4% qoq saar (2.1% yoy) in Q2:17.
The euro area economic recovery is holding up well, with GDP growth revised up to a 2-year high of 2.5% qoq saar (2.2% yoy) in Q2, while PMIs suggest continued strength in Q3 (see Economics).
Chair Yellen’s and President Draghi’s remarks at Jackson Hole focused on regulatory policy (where she supported the financial reforms that were enacted post-crisis) and the need to sustain openness in the global economy. Both offered little insight on the monetary policy outlook.
Market expectations for an interest rate hike by the Fed before end-year remain low (35%), while the ECB meeting on September 7th could provide some clarifications on policy guidance (e.g. a further slowdown of asset purchases from their current levels of €60 bn per month, effective from January 2018). The EUR continues to find support from the prospective ECB tightening, reaching a 2½ year high of $/1.198 on Monday.
The MSCI World declined by 0.5% ($ terms) in August (+12.6% YtD), with EMs overperforming their DM peers (+1.8% vs -0.8%). The S&P 500 fell 1.1% during the same period (+9.1 Ytd), while euro area stocks were broadly flat (EuroStoxx: -0.1%, +6.7% YtD), with banks underperforming (-2.7% / +12.5% YtD), due to lower bond yields and flatter yield curves.
Indeed, on the back of slightly dovish signals from central banks (particularly the Fed minutes of the July meeting) and higher risk aversion, 10-Year Bund yields declined by 17 bps to 0.38%, Treasury yields by 13 bps to 2.17% and UK Gilt yields by 17 bps to 1.05% in August. Curves flattened in major markets, with 10/2Yr spreads lower (-11 bps to 111 bps for Germany, -11 bps to 83 bps for the US).
Corporate bond spreads increased in August, albeit from levels close to multi-year lows. Euro area and US Investment Grade spreads widened by 5 bps to 99 bps and 114 bps, respectively. The rise in the High Yield spectrum was more evident, amid “flight to quality” (US: +28 bps to 389 bps).