Global Weekly: Central bank rhapsody

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This story seems to be repeating itself. If in a given week the markets are suffering under US President Donald Trump’s bellicose trade war tweets, central banks try to put out the fire as much as possible and bring confidence to the market regarding their commitment to support growth. After a pretty bleak month of May, the last few days have seen markets picking up some speed, supported by central banks’ more accommodative (‘dovish’) language.

First, European Central Bank (ECB) President Mario Draghi clearly indicated that ‘if the economic outlook doesn’t improve,’ the ECB was likely to launch another round of monetary stimulus. He also enumerated tools at his disposal to support the economy, such as further rate cuts and renewed asset purchases. Second, the US Federal Reserve, on 19 June, took a large step towards monetary policy easing in the second half of the year. According to the statement issued after its meeting, Fed policymakers state the following: “The Fed Committee continues to view sustained expansion of economic activity, strong labor market conditions and inflation near the Committee's symmetric 2% objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.”

Nonetheless, Fed Chief Jerome Powell also made it clear that he would not rush a rate cut. ABN AMRO expects a growth slowdown in the US in the second half of the year, which is also likely to force the US central bank to cut rates twice by the end of 2019.

The impact of dovish messages from central banks pushed sovereign yields further downward. Ten-year US Treasuries dropped below 200 basis points to 199 basis points, the lowest level since 2016. In Europe, ten-year Bunds hit -32 bps, the lowest level ever. Italian ten-year government bond yields outperformed other European sovereigns, as the Italian bonds returned to 205 bps – a level last seen before the Italian elections. And French government bonds dropped below zero (intraday) for the first time in their history.

On the credit side, Draghi’s dovish comments triggered a rally in European credit markets. The outcome of Powell’s speech should be supportive of risky assets and an increase in appetite for yield. Expecting an accommodative message from central banks, high yield spreads had already tightened in June. The US market tightened by 50 bps, while the European market narrowed by 35 bps. Spread tightening has been limited to double-B and single-B ratings. CCC-ratings widened, a signal of more cautious investor behavior than earlier in the year.

In an environment of decreasing interest rates, within a high-quality fixed-income strategy we expect that bonds with longer maturities have the potential to outperform shorter-maturity bonds. Within a high-return strategy, we prefer emerging-markets debt versus high yield. The dovish stance of the Fed favours emerging-markets bonds. This positioning could get even further support if the US dollar were to weaken. We believe that high-yield bonds remain expensive, with limited potential both in euro-terms or hedged to the US dollar in the medium term.

Equities – All eyes on the G-20 meeting and the Fed

Equity markets had a positive week with modest gains -- around 3% for the S&P 500 Index and the EuroStoxx 600. This increase came as the US Federal Reserve opened the door for interest rate cuts and there was positive news flow regarding a US/China trade deal. In a volatile environment, we continue to favour a neutral stance toward equity.

At the beginning of the week, optimism on progress in the US/China trade negotiations, including about topics such as intellectual property protection, farm good purchases and currency policies, supported the equity market. US President Donald Trump indicated an extended meeting with China President Xi Jinping will take place next week in Japan at the G-20 meeting. Negotiations resulting in a solution to the trade dispute will relieve markets. US Commerce Secretary Wilbur Ross, however, has warned that the meeting was not likely to result in an immediate trade deal, as the parties remain far apart on issues.

On Tuesday, ECB President Mario Draghi indicated additional monetary stimulus will be needed in the absence of any improvement to the outlook for eurozone growth and inflation. He specifically cited rate reductions as a first option. In addition, ECB Vice President Luis de Guindos said another large bond-buying program could be a viable option if inflation in the eurozone does not reach the ECB target level.

At the end of the week, all attention turned to Federal Reserve policymakers. This week, the Fed left interest rates unchanged. Fed Chairman Jerome Powell, however, signaled that a policy rate cut could be likely in the near future in order to sustain the economy. In addition to looser monetary policy, Powell highlighted his intention to serve his full four-year term. This statement came in reaction to several negative statements about him by President Donald Trump. Powell’s commitment to stay is supported by US law and confirms the Fed’s independent statu