Global Weekly: A hectic week

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After the US midterm elections, the relief in the equity markets did not last very long. For most of the week, equity markets were in negative territory. In Europe, political news dominated the headlines.

UK Prime Minister Theresa May managed to reach a deal with the EU on Brexit, which was supported by the Cabinet. However, it remains to be seen whether the Parliament will agree on the deal, as there still is a lot of criticism from people in favour of a Brexit.

Italian Prime Minister Giuseppe Conte informed the European Commission (EC) that Italy is planning to hold on to their budget deficit and economic growth forecast. The latter is much higher than the forecast published by the International Monetary Fund this week, which means that the EC could possibly start a procedure.

We saw the end of the recent sell-off in oil this week, after the WTI oil price dropped for twelve consecutive days. Besides the negative market sentiment and the recent increase in US oil inventories, the US also announced waivers for eight countries against the sanctions in Iran. As a result the MSCI World Energy index underperformed the broader market. We still think that demand for oil in 2019 will be relatively strong and that the organization of petroleum exporting countries (OPEC) might lower their production somewhat, which should be supportive for oil prices. We therefore hold on to our overweight for the energy sector.

The earnings season is now coming to an end. In the US, over 90% of the companies of the S&P500 published their quarterly results, and over 80% of those companies surprised positively on earnings. The US economy is still in relatively good shape, so we continue to advise investors an overweight position in US equities.

This week, we saw good results coming in from companies such as NN Group, Cisco Systems and Tencent Holdings. We saw several component suppliers to Apple, however, lowering their revenue outlook. This has put the share price of Apple under pressure as investors are questioning the maturity of the smart phone market, which still is the biggest source of revenue for Apple.

A tight rope

The risk sentiment among investors keeps determining the moves of the 10-year US Treasury yield in its trading range between 3.12 and 3.335%. The focus this week went to the slight decrease of the 2-year Treasury yield.

The yield of the 10-year US Treasury still remains well above the levels seen over the summer period. In addition to risk sentiment, the latest downward move of the oil price also contributed to a lower bond yield curve, as it will have a subdued impact on the US inflation and growth outlook.

Investment-grade credit spreads are widening and valuations are facing further losses, with the further outflows of corporate credit funds. This pressure comes as investors were moving up in quality and therefore reducing certain risks. The momentum of moving up in quality could hold on, as some issuers face specific challenges. Examples are some issuers from the industrials sector (General Electric), automotive (Volkswagen priced a new deal at much wider credit spreads) and consumer sectors. Given our longer view for credits, we remain constructive on the long run.

Interesting to watch, however, is the slight decrease of the 2-year US Treasury yield. As a consequence, the US Treasury yield curve (a chart showing the yields on bonds of varying maturities, in this case the 2 and 10-year US Treasury yields) has halted its flattening. Now, the difference between the 2 and 10-year US Treasury yield is around 25 basis points (bp). This is matching the 25 bp that the Federal reserve (Fed) is expected to hike next month.

This difference is a tight rope. In previous cycles, a recession followed 9 to 12 months after the yield curve inverted. If the 2-year US Treasury yield is moving up too fast, markets could interpret this as an upcoming end of the economic cycle with a recession as a more likely output.

We are far from such a situation, according to our economists. An inversion is not a done deal. If both equity and oil markets stay under the current pressure, the 2-year US Treasuries yields could decrease even somewhat further, but only temporarily, as the Fed made it clear that they will continue to hike rates. Short-end yields seem to be the safe trade for now, as risky assets are currently facing a reality check.

Markets are facing a more gloomy outlook with a weaker economic outlook for the US, a continuation of the Fed rate hike path, trade tensions with China and Brexit. In an environment where the Fed seems to be at the end of its possibilities (markets already expect three more rate hikes), volatility and tension could be more on investors’ mind. Combined with lower market liquidity going forward, investors should balance risk wisely.

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