Global Economy & Markets, Weekly Roundup 18/09/18

18/09/2018 - Reports

Global Economy and Markets

The ECB remains on track to conclude its net purchases by end-2018, with the first interest rate increase expected in Q4:2019

Key Takeaways

The ECB maintained unchanged its key policy rates (0% and -0.4%) and expects them to remain at their “current levels”, at least through the summer of 2019. Financial markets are pricing in the first full rate increase (+25 bps) in Q1:2020. Net asset purchases will be reduced to €15bn per month (from €30bn per month) and are projected to end by December.

Risks to the euro area growth outlook remain “balanced” following a slight downward revision to the GDP path (see Economics). Trade protectionism, as well as EM markets and financial volatility, offset strong domestic demand.

Global equity markets increased with US equities performing strongly (S&P500: +1.2% wow | +8.7% YtD). Moreover, euro area equities (SXXE) were up by +1.4% wow (-2.8% YtD), led by Banks (+2.6% wow), Autos (+2.7%) and the Energy sector (+3.0%), with oil prices reaching a 4-year high intra-week due to potential disruption from hurricane Florence (see page 3). A confluence of positive economic data, central bank actions in emerging markets (e.g. Turkey, Russia), as well as the continuing saga regarding tariffs lifted risk sentiment. Note that late on Monday, the US announced duties of 10% on $200bn of imports from China. Tariffs will come into effect from September 24th through year-end, and will be raised to 25% on January 1st.

Investor attention has recently switched to the increased divergence between US and global ex-US equities. An accelerating (late-cycle) economic expansion in the US, due to fiscal easing, has allowed for stronger corporate earnings growth and record high buybacks, contributing to an outperformance by US equities over their peers (16% YtD vs Global ex-US).

However, market breadth, defined as the percentage of US companies (i) reaching new highs (see graph below) and (ii) recording closing prices above their 200-day moving average, has largely diminished compared with early 2018 levels. Moreover, concentration has increased, with the Top-10 S&P500 companies now accounting for 23% of total market cap compared with 17% in September 2015, leaving vulnerable the ongoing rally to shocks (see page 3).

Emerging market (EM) equities recovered moderately, with the MSCI EM up by 0.5% wow (-11.2% YtD in $ terms), as EM currencies rebounded against the US dollar (+1% wow | -12.4% YtD), supported by central banks’ actions. Indeed, in Turkey, the CBRT increased its policy rate aggressively by +625 bps to 24% (1-week repo), while in Russia, the CBR hiked (unexpectedly) its main policy rate by +25 bps to 7.5%.

Pro-EM asset catalysts are lacking, but attractive valuation levels, combined with credible EM policy action (if sustained), could enhance the reward-to-risk ratio for investors. Nevertheless, we continue to maintain an underweight position in EM equities in our model portfolio (see Asset Allocation, page 4). A further strengthening of the USD and/or a more hawkish Fed (September 26) would be negative for EM assets.

Improving risk appetite due to strong economic data pushed government bond yields higher. The 2-year US Treasury yield was up by 7.5 bps wow to 2.78% (+89 bps YtD), the highest level since June 2008, supported by strong US growth and ongoing Fed policy tightening expectations.