Global Weekly: Mario Draghi has left the building

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Mario Draghi, the former head of the European Central Bank (ECB) as of month-end, will be remembered for saving the euro, doing “whatever it takes”. He will be less remembered for his last meeting at the ECB on 24 October, which did not surprise or stir markets. Investors will have to wait for the next meeting when his successor, Christine Lagarde, takes over.

Lagarde shares Draghi’s dovish view on monetary policy, but she could be less inclined to simply overrule the view of the more hawkish minority in the Governing council, when the majority depends on the votes of countries such as Malta, together representing less than 2% of the eurozone economy. Divisions within the governing council have escalated into public debate, which has already undermined the effectiveness of ECB policy and is one of the reasons bond yields in Europe have risen more than in the US in the last few months.

Optimism on developments around Brexit and the US/China trade dispute also played a role here, but investors could easily become disappointed, especially on the global trade issues. We therefore expect that Christine Lagarde will need to guide the ECB towards additional action, as the economic outlook continues to deteriorate. Official rates could fall another 10 bp as early as this year, and the ECB could also double to EUR 40 billion the amount of monthly bond purchases in the spring.

The Fed will likely cut rates in October and probably again in December. The December hike could be postponed, however, if the US consumer continues to hold up better than is expected. On balance, this leaves room for interest rates to revisit lows seen in August, when Bund yields touched -0.7% and US Treasury yields fell below 1.5%. It will probably take a much more convincing and substantial breakthrough in the US/China trade dispute to change this outlook. A quick and orderly Brexit would also be helpful, especially for Europe. While keeping an eye on these risks, a moderate overweight of duration (i.e. longer duration) will allow investors to benefit from lower yields.

The economic outlook continues to deteriorate gradually, but a global recession remains unlikely. Together with continuing support from central banks, this creates a constructive environment for corporate bonds, especially in Europe, where the ECB will start buying assets again in November. High-yield bonds are not cheap and we believe are more vulnerable to economic disappointments. The first signs of stress in US markets are now popping up in the more illiquid senior loans segment, and not yet in the high-yield bond market. We continue to prefer emerging-markets bonds, as leading indicators for emerging markets have been the first to hit bottom. But we continue to carefully monitor specific political risks in several countries, mostly in South America.

Earnings season dominates markets

The earnings season is now getting into full swing, joining other headlines on subjects such as the US/China trade dispute and Brexit. In the US, semiconductor companies were the biggest movers. Texas Instruments and Micron Technology reported large revenue and earnings declines and presented weaker outlooks. Texas Instruments, which has products in almost all electronic-component-related markets and acts as a bellwether for the industry, sent semiconductor stocks lower. The electronics industry has been hit by trade woes, as customers cut back on orders as they wait for China and the US to reach a definitive agreement to their trade dispute.

In Europe, where it is still early in the earnings season, a trend of negative earnings growth looks set to continue for the fourth consecutive quarter, while revenue growth is in the low single-digits. As in previous quarters, the energy sector, dominated by oil & gas companies, was the biggest drag on European earnings growth.

The earnings season in China looks to be positive. With almost 500 companies having reported so far, revenue and earnings growth is in the low teens, thus continuing the trend of previous quarters. For the first time in over a year, earnings surprises are positive, i.e. better than expected. Whether this momentum can be sustained, will be revealed in the coming weeks as more companies release their results.