US labor market remains solid
US GDP growth for Q2:17 was revised up to 3.0% qoq saar, the fastest pace since early 2015. The pace of job gains remains consistent with further declines in the unemployment rate, despite a weaker-than-expected figure in August (see Economics section). Strong GDP growth, if confirmed, should start putting pressures on inflation (currently: 1.7% yoy).
In the euro area, above-trend growth continues, with GDP at 2.5% in Q2:2017 (annualized rate). Actual and survey-based inflation data show signs of accelerating, with core CPI above the 1% mark recently (1.2% in August). Nevertheless, the sharp appreciation of the euro, if sustained, could brake inflation dynamics (+5% in nominal trade-weighted terms since mid-May).
Thus, we do not expect any major policy announcements by the ECB on Thursday. A QE exit strategy is expected to be revealed most probably in October. The concurrent management of interest rate expectations will be a challenge.
Indeed, according to former Fed Chair Bernanke (Brookings, January 2017), much of the “taper-tantrum” reaction (10-year UST yields rose by 90 bps to 3.0% between May and December 2013) came through the signaling channel, as some market participants inferred that slower asset purchases by the Fed would also imply a faster increase in short-term interest rates.
Global corporate earnings continue to recover, and equities offer a superior return compared with bonds as the Equity risk premium (12 month forward Earnings Yield (inverse of P/E) minus real yield of US 10Y bond) remains above long-term averages (currently: 4.1% vs a 20-year average of 3.4%).
Nevertheless, (i) investors believe that equities are expensive and (ii) central bank liquidity, that supported equities since 2009, will be gradually reversed during 2018. For now, we retain a small overweight in equities (see page 4).
US Equities have over-performed their DM peers year-to-date (360 bps vs Eurostoxx & 760 bps vs Nikkei225) in local currency terms. In our view, strong US growth in Q2/Q3 and the USD decline of 8% in NEER terms year-to-date could offset diminishing expectations for aggressive tax cuts.
Euro area equities lag (in local currency terms – see graph), with the Eurostoxx down by c. 4% since its peak in May (7.0% ytd), with the strong euro taking its toll on earnings expectations. Domestic-focused sectors, including Banks (29% foreign exposure vs 43% market-average) may benefit compared with their export-oriented peers, assuming that the EUR strength continues.
EM assets (equities & bonds) continue their strong performance vs DM assets, overperforming by 1360 bps (equities) and 667 bps (government bonds), both in $ terms, ytd. However, emerging economies growth has slowed recently (according to the IIF tracker 5.1% vs peak 6.7%), portfolio inflows have stalled during the past 3-4 weeks, and investor pessimism regarding the Fed (that resulted in lower USD & yields – both supportive factors for EM assets) may reverse.