Coffee Break 25.09.2017

Central banks were at the forefront over the past week. As expected, the Fed kept its interest rate unchanged and set October as a start date for balance sheet reduction. After another step in the Federal Reserve’s plan to gradually remove its monetary accommodation by reducing its balance sheet, the next step appears to be more controversial. As of today, the market expects only two increases by the end of 2018. This is at odds with the Fed’s own projections of four additional hikes, despite the recent weakening of core inflation.
We expect one hike in December 2017, followed by two additional hikes next year. In our thinking this should lead to a gradual rise in long term yields and an additional upward adjustment in market expectations.
In an initial reaction, the USD rallied, with the GBP and the EUR down respectively by 0.7% and 0.9% against the greenback.

Furthermore, the Bank of Japan kept monetary policy steady last Thursday and maintained its upbeat view of the economy, signalling its conviction that a solid recovery will gradually accelerate inflation towards its 2% target without additional stimulus.

The result of the general election in Germany means that Chancellor Merkel will start talks to form a coalition government immediately but the negotiations could last several weeks.

We remain overall overweight on equities and keep a short duration and this week, we will closely follow the OPEC meeting this Thursday.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are positive on equities and remain negative on bonds, maintaining a short duration:

• The robustness of the global economic news flow is supportive. The outlook for the world economy appears solidly anchored above 3% for both this year and the next, while inflationary pressures remain subdued.
  • The euro zone and Japan are expanding above potential.
  • Emerging markets benefit from the bottoming-out of commodities, the USD weakness and the decline in inflationary pressures.
  • In this context, we concentrate our portfolio’s regional positioning on the euro zone, Japan and the Emerging markets.
• Central bank are expected to adapt their monetary policies in the coming months:
  • The Fed will start its balance sheet reduction in October.
  • The ECB will likely announce its tapering in October.
  • Overall, central banks are confident on the synchronised global growth context and are prudently adopting a tightening bias.
• Equities have an attractive relative valuation compared to credit.
• The main risks for equity markets remain political and mainly concern the US, where the risk of legislative delay in pro-growth policies has increased. Although the temporary agreement to lift the debt ceiling was a relief, expectations for more clarity on both domestic and international issues in the foreseeable future have fallen.

REGIONAL EQUITY STRATEGY

• We continue to favour euro zone equities. Q2 GDP data have confirmed the on-going, more robust and geographically broadening economic expansion while the ECB remains accommodative and corporate earnings keep their strong momentum. The pause in the recent increase in the EUR acts as a support after a more challenging summer for EMU equities.
• We remain negative on Europe ex-EMU, especially the UK. The deterioration in the “Brexit” negotiations, the difficulties to setup new trade relations (e.g. with Japan) and their impact on the economy pushes us to avoid the region.
• We keep our neutral stance on US equities. There is an execution risk in the announced fiscal stimulus and pro-growth policies. Nevertheless, we note that there are timid movements towards a bi-partisan approach in Washington.
• We are positive on Japanese equities. A strengthening growth and a supportive domestic policy mix are among the main performance drivers and we have gained more conviction that the BoJ will not join other central banks in tightening its monetary policy anytime soon, which should ultimately lead to a weaker JPY. Despite the likely snap election, political risk should be limited.
• Emerging market equities remain one of our regional overweighing as they have performed well recently on improving fundamentals and a weakening USD. In a context of robust global growth, the upcoming National Congress of the Communist Party of China will be the next important milestone.

BOND STRATEGY

• We are negative on bonds and have a low duration. We expect rates and bond yields to resume their uptrend from this month’s low, driven by a tightening Fed, and potential upcoming inflation pressures. The improvement in the European economy could also lead EMU yields higher.
• We continue to diversify out of low-yielding government bonds:
  • We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • We have a diversification in inflation-linked bonds.
  • We keep our diversification to emerging market debt, as the on-going monetary easing represents an important support.
  • We are more or less neutral on high yield.
• On the currency side, we maintain a lower USD exposure as the EUR/USD exchange rate broke key resistance levels.

• In the US, initial jobless claims unexpectedly fell to 259,000 against expectations of 300,000, the Labor department said. The weekly figures were once again affected by hurricanes in the region.
• The Philadelphia Fed’s manufacturing index rose by 5 points to a three-month high at 23.8 in September. Besides, the current indicators for general activity, new orders and shipments all increased this month.
• In the euro zone, overall economic activity unexpectedly improved in September as shown by the Markit flash composite PMI which increased to 56.7 this month, up from the prior month’s reading of 55.7. This was the highest reading since May.
• In Germany, the ZEW economic sentiment jumped by 7 points to 17 in September, above market consensus of 13. The improvement was boosted by solid Q2 growth figures in combination with a steep rise in bank lending and increasing investment activities by both the government and private firms. 

EUROPE

Reflation themed rally for European equities last week.

• The broadening rise in developed markets’ inflation and the hawkish shift for several central banks on the back of increasing global growth boosted European markets.
• Oil & Gas outperformed helped by higher crude oil price.
• Cyclicals outperformed defensives by 75bps.
• Food & Beverage was the worst performer dragged down by Heineken after Mexican bottler FEMSA sold a stake in the brewer for EUR 2.5 bn.
• Johnson Matthey rose heavily last week and lifted the Chemicals sector.

US

Mixed week for US equities.

• Both S&P 500 and DJIA were mostly flat on Friday after having set record highs early in the week.
• Interest rate-sensitive utilities and real estate companies performed poorly following the FOMC on Wednesday.
• Energy stocks fared well as oil prices hit a three-month high, helped by increasing demand after the hurricanes in the Gulf of Mexico.
• Republican efforts to pass a new health care bill to replace the Obamacare legislation seemed to have little impact, although health care services stocks fell sharply on Tuesday before recovering somewhat.

EMERGING MARKETS

Flattish week for emerging equities.

• A more hawkish Fed than expected and the pursuing turmoil in North Korea put some pressure on Emerging stocks last week.
• Apple-related Taiwanese technology stocks weakened on a somewhat disappointing presentation of the new iPhones.
• Following China’s rating being lowered by S&P, Shanghai, Shenzhen and Hong Kong stock markets lost some grounds (from -0.34% to -0.82%). 

RATES

Government bond yields moved higher last week.

• After the FOMC signalled a strong consensus to hike rates one more time this year while starting its balance sheet normalisation in October, government bond yields moved higher.
• On the periphery, Portuguese bond yields slid over 35bp after S&P upgraded the country’s rating to investment grade (from BB+ to BBB-) while Spanish and Italian spreads versus Germany were broadly unchanged.
• 10Y US, UK, Japan and German yields stood at respectively 2.25%, 1.36%, 0.004% and 0.45%. 

CREDIT

Positive week for the credit market.

• Investment grade lost 2bp and high yield cash 8bp last week, in line with derivatives (-2bp and -10bp).
• Intense activity on the primary market with over EUR 15.7bn of investment grade supply, the heaviest since May.
• Quiet week for financials despite some press reports indicating a potential merger of Commerzbank with Unicredit or BNP Paribas.
• Subordinated indexes (CoCo’s and Tier 2) stayed flat. 

FOREX

Little Fed effect on the USD.

• The unwind of the balance sheet reduction by the Fed had little impact on the USD last week as this was quickly muted by another wave of geopolitical risk with North Korea and a persistent long term bearish view on the US economy.
• The EUR kept its positive momentum as the euro zone economic activity is still beating expectations.
• Only the NOK outperformed as its central bank slightly upgraded its rate path for 2018 and 2019. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES