Improving economic indicators, ongoing accommodative monetary policy from the Fed and the bountiful reporting season have propelled U.S. equity indices to new highs in recent days: the S&P has added gains of 6% in the last three months making for a YTD gain of 18% and has even flirted with the 2,000 point level. The confidence backing up these trends is, however, a far cry from the signals the bond markets are sending us. Since the end of April, the yield on 10-year T-bonds has fallen to below 2.50%, i.e. 25 basis points less than mid-April levels and 50bps off from where it started the year. Such distortions between equity and bond markets are tough to reconcile over the duration and will end up being corrected. It is merely a question of when and to what extent. The response will come from economic changes in the coming months. So what should the market being taking a very hard look at?
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Day to day Global Macro Context Analysis
U.S. Real Estate, Does It Still Matter?
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The U.S. housing recovery, considered a slam dunk by the vast majority of economists since spring 2012, has sputtered since summer 2013. Even though most economic indicators have been pointed higher in recent months, real estate has been the odd man out. Housing starts have been wildly unstable from one month to the next and are hardly increasing at all. At less than 900,000 housing units in June, they are on par with end-2012 and still a long way away from returning to their long-term average, while many observers predicted they would do so by the end of this year.
How worried should we be? What would happen if activity in this sector failed to return to normal levels during the current cycle? What weight will the Fed give to these disappointments in its decision-making process?
Now What Do We Do?
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The raft of data coming out of the euro area in recent weeks has been more and more mediocre and has erased all doubts: the strategy for extricating the economy from the crisis in the past few years has been a failure. None of the mechanisms born of resulting from decisions made by European leaders have delivered results or are about to:
-the structural policies aimed at improving competitiveness have failed, because global trade is tanking
-as proof: Germany’s export outlook is sputtering and the ability of the euro area’s biggest economy to act as the region’s growth driver (i.e. its “appointed” role) is going up in smoke;
-fiscal austerity’s only effect, under such conditions, is to fuel deflationary pressures and are counter-productive in controlling public debt levels.
These failures hardly come as a surprise. Like many of our peers, we have been decrying these shortcomings but did we really need to spell them out before hoping to make a convincing enough argument to effect the urgent change in the direction of European economic policy? With the situation becoming increasingly dire, where should, at present, our fears and hopes lie?
No QE, so we’ll have to settle for the minutes…
The ECB says it needs time to beef up its anti-deflation measures. Let’s not kid ourselves, the bank is in no hurry. There seems to be but one justification for its move to space out its meetings from every four to every six weeks and the innovation that consists of publishing its minutes: deflate ballooning expectations of future intervention.
This, in reality, was the only take-away from the ECB’s monthly monetary policy meeting held this week. In other words, there is no revolution under the European skies: the pace of change is still in slow motion and lacking in ambition.
Mind your Back!
France is stumbling, Germany weakening, the U.S. wobbling, Brazil is down a match point and J. Bullard has promised us rate hikes by March… the summer is going to be a real barn burner! Will M&A activity be robust enough to continue to fuel investor confidence?
It’s looking like things are getting tight, considering recent economic developments and central banks’ bungled messages. Let’s take a closer look at the most disruptive factors from the week.
– Euro area: if Germany is a locomotive, is France the caboose?
– U.S. growth will not exceed 1.5% this year
– It’s match point in Brazil
– Beware of the impatience of certain central bankers
Fed calm things down
No stress: that’s how the message sent by the Fed after its FOMC meeting on June 18th can be summed up. Through a statement, it left its message from April pretty much unchanged, thus leaving no room for excessive reactions in either direction. Janet Yellen excelled at this balancing game even as the environment had grown increasingly tense in the few days before the meeting.
By calming things down, Janet Yellen has snuffed out the risk of runaway anticipations and opened the door to a correction on the two-year, whose levels had become dangerously tight in the last two weeks.
The Fed’s consistent message is a stabilizing factor amid growing geo-political tension and, consequently, stress on the price of oil.
On balance, today’s communication strengthened our expectations, validating our scenario that the probability of an interest rate hike in the foreseeable future is low. Growing concerns over the possibility of a sustained gap in long-term interest rates between the US and the euro area should ease, which also reduces the likelihood of the dollar strengthening much versus the euro.
Geo-political and oil risk notwithstanding, the overall picture is mostly favorable for equities on both sides of the Atlantic but could also prove promising for gold, given the risks associated with future developments in the situation in Iraq
After the ECB’s big flop, is there a life raft to cling to?
Too little too late or simply lacking credibility, the ECB’s announcement was a flop. While for many observers, the measures were supposed to drive the euro down, give stock markets a shot in the arm (particularly banking and cyclical stocks) and increase the level of long rates by brightening the euro area outlook, by all accounts, they failed to win over the markets. The stock markets are stumbling, bank stocks sagging, bund yields have hardly budged and the euro is about where it was prior to the June 6th announcement. Of course, all is not lost but it seems that we’ll have to look elsewhere: the US, China or even Iraq, which, at the time of publication, was the most pressing concern. Everywhere markets look, the rosier scenario is simply not materializing.
Ground Zero
Will the raft of measures announced by the ECB be enough to restore growth in the euro area? The answer will depend on the following three factors:
– The effective size of the package,
– The ability of demand for credit to be stimulated,
– The return of a more favorable international economic context, which provides an outlet for improved competitiveness that has been at the origin of deflationary risk.
The markets have been circumspect with regard to these measures because none of these factors are guaranteed to materialize at this point.