Global Weekly: All eyes on the slowing economy

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Equity markets had a negative week with losses of 3% for the S&P 500 Index and the Euro Stoxx 600 Index, as the US Federal Reserve indicated additional rate hikes might be needed and company outlooks reflected a slowing economy.

In this volatile environment, we continue to favor an overweight position in stocks, as political risks related to a (hard) Brexit, the US/China trade war and Italian budget issues could abate in the coming months.

At the beginning of the week, China indicated that it will remove its 25% retaliatory taxes of on autos imported from the US for three months, in an effort to defuse trade tensions. The US and China plan to meet in January 2019 to negotiate a peace in their trade war – which would be a relief to the stock market.

Shares of computer memory manufacturer Micron, e-commerce retailer Asos and transporter FedEx, plummeted, after management outlooks turned more negative, largely related to slower economic growth. We believe that earnings revisions are more likely to be downward in the coming months. This is based on analysts adapting to a lower growth environment. We do not, however, expect a recession.

The Fed stole the spotlight at the end of the week, as policymakers increased interest rates by 25 basis points. It was the fourth such increase in 2018. Although the Fed signaled a less aggressive rate-hike path in 2019 (reducing the number of expected hikes to two instead of three), stock markets reacted negatively. A more accommodative tone had been expected, especially after the recent market turbulence. Fed Chief Jerome Powell also flagged the threat of a softening world economy.

Treasury and Bund yields drop

With the hike in interest rates by the US Federal Reserve this week, short-term US rates moved relatively sideways, while longer-term US rates declined significantly. For the first time since August, 30-year US Treasury yields fell below 3%.

A similar movement could be observed in Europe. Ten-year German Bund yields dropped close to the threshold of 20 basis points during the week, the lowest level since the start of the year. Economic worries as well as declining inflation expectations may continue to support the demand for high-quality government bonds for now.

The EU and Italy were able to solve their budget dispute. Risk premiums for Italian government bonds as well as for Italian financials declined significantly as a result. We see further room for spread tightening and expect less headline risks in the months ahead for peripheral government bonds.

Risk premiums for European investment-grade corporate bonds remained steady during the week, but are still close to the highs for the year seen in mid-December. Even though we expect only slower growth in 2019, not a recession, market sentiment seems considerably damaged. US high-yield bonds suffered more than European high yield, given that the US high-yield market is more exposed to the energy sector and were therefore hurt by the recent drop in oil prices. In addition, the lower rating quality of the US universe and the later position of the US in the economic cycle might provoke investors to react erratically on negative news flow.

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